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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. Bengt Holmstrom & Jean Tirole, 1994. "Financial Intermediation, Loanable Funds and the Real Sector," Working papers 95-1, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Laura Alfaro & Sebnem Kalemli-Ozcan & Vadym Volosovych, 2005. "Why Doesn't Capital Flow from Rich to Poor Countries? An Empirical Investigation," NBER Working Papers 11901, National Bureau of Economic Research, Inc.
  3. Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2003. "Debt Intolerance," NBER Working Papers 9908, National Bureau of Economic Research, Inc.
    • Reinhart, Carmen & Rogoff, Kenneth & Savastano, Miguel, 2003. "Debt intolerance," MPRA Paper 13932, University Library of Munich, Germany.
  4. Fernando Broner & Jaume Ventura, 2010. "Rethinking the effects of financial liberalization," Economics Working Papers 1128, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2013.
  5. Arteta, Carlos & Hale, Galina, 2008. "Sovereign debt crises and credit to the private sector," Journal of International Economics, Elsevier, vol. 74(1), pages 53-69, January.
  6. Holmstrom, B & Tirole, J, 1996. "Private and Public Supply of Liquidity," Working papers 96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
  7. Christoph Trebesch, 2009. "The Cost of Aggressive Sovereign Debt Policies; How Much is theprivate Sector Affected?," IMF Working Papers 09/29, International Monetary Fund.
  8. Sandleris, Guido, 2008. "Sovereign defaults: Information, investment and credit," Journal of International Economics, Elsevier, vol. 76(2), pages 267-275, December.
  9. Bulow, J. & Rogoff, K., 1988. "Sovereign Debt: Is To Forgive To Forget?," Papers 411, Stockholm - International Economic Studies.
  10. 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.
  11. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2001. "International and domestic collateral constraints in a model of emerging market crises," Journal of Monetary Economics, Elsevier, vol. 48(3), pages 513-548, December.
  12. Alexander Guembel & Oren Sussman, 2009. "Sovereign Debt without Default Penalties," Review of Economic Studies, Oxford University Press, vol. 76(4), pages 1297-1320.
  13. 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.
  14. Oren Sussman & Alexander Guembel, 2005. "Sovereign Debt Without Default Penalties," OFRC Working Papers Series 2005fe17, Oxford Financial Research Centre.
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