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Internal Debt Crises and Sovereign Defaults

  • Narayana Kocherlakota

    (University of Minnesota)

  • Cristina Arellano

    (University of Minnesota)

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 Society for Economic Dynamics in its series 2008 Meeting Papers with number 139.

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Date of creation: 2008
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Handle: RePEc:red:sed008:139
Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Web page: http://www.EconomicDynamics.org/society.htm
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  1. Bulow, J. & Rogoff, K., 1988. "Sovereign Debt: Is To Forgive To Forget?," Papers 411, Stockholm - International Economic Studies.
  2. Gerard Caprio & Patrick Honohan, 2008. "Banking Crises," Center for Development Economics 2008-09, Department of Economics, Williams College.
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  5. Hoyt Bleakley & Kevin Cowan, 2002. "Corporate dollar debt and depreciations: much ado about nothing?," Working Papers 02-5, Federal Reserve Bank of Boston.
  6. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc.
  7. Kocherlakota Narayana R, 2001. "Risky Collateral and Deposit Insurance," The B.E. Journal of Macroeconomics, De Gruyter, vol. 1(1), pages 1-20, February.
  8. A. Rampini, Adriano, 2005. "Default and aggregate income," Journal of Economic Theory, Elsevier, vol. 122(2), pages 225-253, June.
  9. Eaton, Jonathan, 1987. "Public Debt Guarantees and Private Capital Flight," World Bank Economic Review, World Bank Group, vol. 1(3), pages 377-95, May.
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  13. Cole, Harold L & Kehoe, Timothy J, 2000. "Self-Fulfilling Debt Crises," Review of Economic Studies, Wiley Blackwell, vol. 67(1), pages 91-116, January.
  14. Mark Aguiar & Gita Gopinath, 2004. "Defaultable debt, interest rates, and the current account," Working Papers 04-5, Federal Reserve Bank of Boston.
  15. Carmen M. Reinhart & Kenneth S. Rogoff, 2008. "This Time is Different: A Panoramic View of Eight Centuries of Financial Crises," NBER Working Papers 13882, National Bureau of Economic Research, Inc.
  16. Guillermo A. Calvo, 1998. "Capital Flows and Capital-Market Crises: The Simple Economics of Sudden Stops," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 35-54, November.
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  19. Jeremy Bulow & Kenneth Rogoff, 1989. "Sovereign Debt Repurchases: No Cure for Overhang," NBER Working Papers 2850, National Bureau of Economic Research, Inc.
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  27. repec:ner:tilbur:urn:nbn:nl:ui:12-154416 is not listed on IDEAS
  28. Ilhyock Shim & Narayana Kocherlakota, 2005. "Forbearance and prompt corrective action," BIS Working Papers 177, Bank for International Settlements.
  29. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
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  32. Bulow, J. & Rogof, K., 1989. "Sovereign Debt Repurchases: No Cure For Overhang," Working papers 8903, Wisconsin Madison - Social Systems.
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  34. Hoyt Bleakley & Kevin Cowan, 2005. "Corporate Dollar Debt and Depreciations: Much Ado about Nothing?," IDB Publications (Working Papers) 6693, Inter-American Development Bank.
  35. Reinhart, Carmen & Kaminsky, Graciela, 1998. "On crises, contagion, and confusion," MPRA Paper 13709, University Library of Munich, Germany.
  36. Fabian Valencia & Luc Laeven, 2008. "Systemic Banking Crises; A New Database," IMF Working Papers 08/224, International Monetary Fund.
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  38. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sergio, 2004. "Government guarantees and self-fulfilling speculative attacks," Journal of Economic Theory, Elsevier, vol. 119(1), pages 31-63, November.
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