Working Paper: CEPR ID: DP6035
Authors: Bernardo Guimaraes
Abstract: This paper analyses whether sovereign default episodes can be seen as contingencies of optimal international lending contracts. The model considers a small open economy with capital accumulation and without commitment to repay debt. Taking first order approximations of Bellman equations, I derive analytical expressions for the equilibrium level of debt and the optimal debt contract. In this environment, debt relief generated by reasonable fluctuations in productivity is an order of magnitude below that generated by shocks to world interest rates. Debt relief prescribed by the model following the interest rate hikes of 1980-81 accounts for a substantial part of the debt forgiveness obtained by the main Latin American countries through the Brady agreements.
Keywords: default; optimal contract; sovereign debt; world interest rates
JEL Codes: F3; F4; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| sovereign default episodes (F34) | optimal international lending contracts (F34) |
| higher domestic productivity (O49) | increased borrowing (H74) |
| fluctuations in world interest rates (E43) | debt relief (F34) |
| interest rate fluctuations (E43) | debt relief outcomes (F34) |
| costs associated with defaulting (G33) | inhibit capital flows (F32) |
| renegotiation of debt (F34) | debt relief (F34) |