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Internal Debt Crises and Sovereign Defaults

  • Cristina Arellano
  • Narayana R. Kocherlakota

In this paper, we use data from developing countries to argue that sovereign defaults are often caused by fiscal pressures generated by large-scale domestic defaults. We argue that these systemic domestic defaults are caused by shocks best interpreted as being non-fundamental. We construct a model that is consistent with these observations. The key ingredient of the model is that it is impossible to liquidate large amounts of entrepreneurial assets. This restriction generates the possibility of a domestic coordinated default crisis, in which domestic borrowers find it optimal to default because all other borrowers are also defaulting. We conclude that avoiding sovereign defaults requires better internal institutions, not better external ones.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13794.

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Date of creation: Feb 2008
Date of revision:
Publication status: published as Arellano, Cristina & Kocherlakota, Narayana, 2014. "Internal debt crises and sovereign defaults," Journal of Monetary Economics, Elsevier, vol. 68(S), pages S68-S80.
Handle: RePEc:nbr:nberwo:13794
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