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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
Fax: 1-314-444-8731
Web page: http://www.EconomicDynamics.org/society.htm
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