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The Twin Ds: Optimal Default and Devaluation

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  • Seunghoon Na
  • Stephanie Schmitt-Grohé
  • Martin Uribe
  • Vivian Z. Yue

Abstract

A salient characteristic of sovereign defaults is that they are typically accompanied by large devaluations. This paper presents new evidence of this empirical regularity known as the Twin Ds and proposes a model that rationalizes it as an optimal policy outcome. The model combines limited enforcement of debt contracts and downward nominal wage rigidity. Under optimal policy, default is shown to occur during con- tractions. The role of default is to free up resources for domestic absorption, and the role of exchange-rate devaluation is to lower the real value of wages, thereby reducing involuntary unemployment.

Suggested Citation

  • 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.
    • Handle: RePEc:nbr:nberwo:20314
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F38 - International Economics - - International Finance - - - International Financial Policy: Financial Transactions Tax; Capital Controls
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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