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Sovereign Defaults, Domestic Credit Market Institutions and Credit to the Private Sector

  • Guido Sandleris

During sovereign debt crises, even after controlling for the decline in relevant macroeconomic variables, both foreign and domestic credit to the private sector decline. This paper presents a mechanism through which sovereign defaults can lead to this decline, even if domestic agents do not hold government debt. The mechanism highlights the interaction between sovereign defaults, domestic credit market institutions and firms’ collateral constraints. In developing countries firms are usually collateral constrained. In a model with endogenous sovereign debt, a sovereign default, through its effect on expectations about fundamentals, affects the value of the firms’ international and domestic collateral, which limits the availability of foreign and domestic credit. The model also shows that, by attracting private capital flows to the private sector, stronger domestic financial institutions reduce governments’ incentives to default, which, in turn, facilitate public borrowing.

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Paper provided by Universidad Torcuato Di Tella in its series Business School Working Papers with number 2010-01.

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Length: 25 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:udt:wpbsdt:2010-01
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Web page: http://www.utdt.edu/listado_contenidos.php?id_item_menu=4994

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  1. Sebnem Kalemli-Ozcan & Laura Alfaro & Vadym Volosovych, 2003. "Why doesn’t Capital Flow from Rich to Poor Countries? An Empirical Investigation," Working Papers 2003-01, Department of Economics, University of Houston.
  2. Carlos Arteta & Galina Hale, 2006. "Sovereign debt crises and credit to the private sector," Working Paper Series 2006-21, Federal Reserve Bank of San Francisco.
  3. Guido Sandleris, 2008. "Sovereign Defaults: Information, Investment and Credit," Business School Working Papers 2008-04, Universidad Torcuato Di Tella.
  4. Bengt Holmstrom & Jean Tirole, 1998. "Private and Public Supply of Liquidity," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 1-40, February.
  5. Alexander Guembel & Oren Sussman, 2009. "Sovereign Debt without Default Penalties," Review of Economic Studies, Oxford University Press, vol. 76(4), pages 1297-1320.
  6. Fernando A. Broner & Jaume Ventura, 2010. "Rethinking the Effects of Financial Liberalization," NBER Working Papers 16640, National Bureau of Economic Research, Inc.
  7. Jeremy I. Bulow & Kenneth Rogoff, 1988. "Sovereign Debt: Is To Forgive To Forget?," NBER Working Papers 2623, National Bureau of Economic Research, Inc.
  8. Reinhart, Carmen & Rogoff, Kenneth & Savastano, Miguel, 2003. "Debt intolerance," MPRA Paper 13932, University Library of Munich, Germany.
  9. Christoph Trebesch, 2009. "The Cost of Aggressive Sovereign Debt Policies; How Much is theprivate Sector Affected?," IMF Working Papers 09/29, International Monetary Fund.
  10. Oren Sussman & Alexander Guembel, 2005. "Sovereign Debt Without Default Penalties," OFRC Working Papers Series 2005fe17, Oxford Financial Research Centre.
  11. Holmström, Bengt & Tirole, Jean, 1994. "Financial Intermediation, Loanable Funds and the Real Sector," IDEI Working Papers 40, Institut d'Économie Industrielle (IDEI), Toulouse.
  12. Ricardo Caballero & Arvind Krishnamurthy, 2000. "International and Domestic Collateral Constraints in a Model of Emerging Market Crises," NBER Working Papers 7971, National Bureau of Economic Research, Inc.
  13. 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.
  14. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
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