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A Quantitative Model of Sovereign Debt, Bailouts and Conditionality

  • Fabian Fink

    ()

    (Department of Economics, University of Konstanz, Germany)

  • Almuth Scholl

    ()

    (Department of Economics, University of Konstanz, Germany)

International Financial Institutions provide temporary balance-of-payment support contingent on the implementation of specific macroeconomic policies. While several emerging markets repeatedly used conditional assistance, sovereign defaults occurred. This paper develops a dynamic stochastic model of a small open economy with endogenous default risk and endogenous participation rates in bailout programs. Conditionality enters as a constraint on fiscal policy. In a quantitative application to Argentina the model mimics the empirical duration and frequency of bailout programs. In equilibrium, conditional bailouts generate high and volatile interest spreads. A Laffer-curve in conditionality reflects the trade-off between fostering fiscal reform and creating incentives for non-compliance.

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Paper provided by Department of Economics, University of Konstanz in its series Working Paper Series of the Department of Economics, University of Konstanz with number 2011-46.

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Length: 29 pages
Date of creation: 30 Nov 2011
Handle: RePEc:knz:dpteco:1146
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