Working Paper: NBER ID: w13794
Authors: Cristina Arellano; Narayana R. Kocherlakota
Abstract: 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.
Keywords: Sovereign Defaults; Domestic Debt Crises; Fiscal Pressures; Nonfundamental Shocks
JEL Codes: F34; G33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| large-scale domestic defaults (G33) | fiscal pressures on governments (E62) |
| fiscal pressures on governments (E62) | sovereign defaults (F34) |
| internal debt crises (F34) | sovereign defaults (F34) |
| domestic borrowers defaulting (H74) | government tax revenues decrease (H29) |
| domestic borrowers defaulting (H74) | fiscal burdens increase due to bailouts (H69) |
| domestic defaults (G33) | coordinated default crisis among borrowers (F65) |
| nonfundamental shocks (E32) | large-scale domestic defaults (G33) |
| domestic defaults (G33) | social loss in liquidation processes (G33) |
| internal debt crises precede (F34) | sovereign defaults (F34) |