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Decentralized Borrowing and Centralized Default

Author

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  • Yun Jung Kim

    (University of Michigan)

  • Jing Zhang

    (University of Michigan)

Abstract

In the past, foreign borrowing by developing countries was comprised almost entirely of government borrowing. Recently, private firms and individuals in developing countries borrow substantially from foreign lenders. It is not clear whether the observed increase in private sector borrowing leads to overborrowing and frequent defaults by governments in developing countries. In this paper, we develop a tractable quantitative model in which private agents decide how much to borrow but the government decides whether to default. The model with decentralized borrowing increases aggregate credit costs and sovereign default risk, and reduces aggregate welfare, relative to a model with centralized borrowing. Private agents do not internalize the effect of their borrowing on economy-wide credit costs and thus would like to borrow more than the socially efficient level. Depending on the severity of default penalties, decentralized borrowing may lead to either too much or too little debt in equilibrium. The introduction of decentralized borrowing substantially improves the model's empirical fit in terms of matching observed debt levels and default rates.

Suggested Citation

  • Yun Jung Kim & Jing Zhang, 2010. "Decentralized Borrowing and Centralized Default," Working Papers 596, Research Seminar in International Economics, University of Michigan.
  • Handle: RePEc:mie:wpaper:596
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    File URL: http://www.fordschool.umich.edu/rsie/workingpapers/Papers576-600/r596.pdf
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    References listed on IDEAS

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    Cited by:

    1. repec:eee:macchp:v2-1697 is not listed on IDEAS
    2. Cristina Arellano & Andrew Atkeson & Mark Wright, 2016. "External and Public Debt Crises," NBER Macroeconomics Annual, University of Chicago Press, vol. 30(1), pages 191-244.
    3. Seunghoon Na & Stephanie Schmitt-Grohe & Martin Uribe & Vivian Z. Yue, 2014. "A Model of the Twin DS: Optimal Default and Devaluation," Emory Economics 1404, Department of Economics, Emory University (Atlanta).
    4. Seon Tae Kim & Gabriel Mihalache & Yan Bai, 2014. "Maturity and Repayment Structure of Sovereign Debt," 2014 Meeting Papers 523, Society for Economic Dynamics.
    5. Na, Seunghoon & Schmitt-Grohé, Stephanie & Uribe, Martín & Yue, Vivian, 2015. "A Model of the Twin Ds: Optimal Default and Devaluation," CEPR Discussion Papers 10697, C.E.P.R. Discussion Papers.
    6. Na, Seunghoon & Schmitt-Grohe, Stephanie & Uribe, Martin & Yue, Vivian Z., 2015. "A model of the Twin Ds: optimal default and devaluation," FRB Atlanta CQER Working Paper 2015-1, Federal Reserve Bank of Atlanta.
    7. Tavares, Tiago, 2015. "Labor Market Distortions under Sovereign Default Crises," MPRA Paper 66964, University Library of Munich, Germany.
    8. Aguiar, M. & Chatterjee, S. & Cole, H. & Stangebye, Z., 2016. "Quantitative Models of Sovereign Debt Crises," Handbook of Macroeconomics, Elsevier.
    9. Charles-Henri Weymuller & Eduardo Davila, 2016. "Optimal Joint Bond Design," 2016 Meeting Papers 1447, Society for Economic Dynamics.
    10. Gondo, Rocío, 2013. "Default Externalities in Emerging Market Systemic Private Debt Crises," Working Papers 2013-023, Banco Central de Reserva del Perú.
    11. Mehmet Behzat Ekinci, 2016. "External Borrowing and Inflation in Turkey Between 2003 and 2015: A Simple Linear Regression Analysis," International Journal of Economics and Financial Issues, Econjournals, pages 45-54.
    12. Seunghoon Na & Stephanie Schmitt-Grohé & Martin Uribe & Vivian Z. Yue, 2014. "The Twin Ds: Optimal Default and Devaluation," NBER Working Papers 20314, National Bureau of Economic Research, Inc.
    13. Vivian Yue & Stephanie Schmitt-Grohe & Martin Uribe & Seunghoon Na, 2015. "A Model of the Twin Ds: Optimal Default and Devaluation," 2015 Meeting Papers 419, Society for Economic Dynamics.

    More about this item

    Keywords

    Sovereign Default; Sovereign Debt; Private Borrowing; Capital Flows;

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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