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The Welfare Cost of Sovereign Default and Liquidity Injections

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  • Guangling Liu

    (Department of Economics, University of Stellenbosch)

Abstract

This paper develops a dynamic general equilibrium model with endogenous default on entrepreneur loans and funds borrowed from the central bank (liquidity injections) and investigates the welfare cost of sovereign default. The results show that sovereign default affects production through households' investment decisions and the bank's asset portfolio adjustment. The effect of sovereign default on entrepreneurs tends to be in favor of production. Sovereign default reduces the variability of the output gap and hence the welfare loss. Liquidity injections reduce the variability of the output gap and improve price stability during the period of sovereign debt crisis, resulting in an increase in households' welfare.

Suggested Citation

  • Guangling Liu, 2014. "The Welfare Cost of Sovereign Default and Liquidity Injections," Working Papers 12/2014, Stellenbosch University, Department of Economics.
    • Handle: RePEc:sza:wpaper:wpapers217
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    References listed on IDEAS

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    More about this item

    Keywords

    sovereign default; welfare cost; debt crisis; rollover risk; liquidity;
    All these keywords.

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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