Working Paper: NBER ID: w19477
Authors: Pablo Derasmo; Enrique G. Mendoza
Abstract: Europe’s debt crisis resembles historical episodes of outright default on domestic public debt about which little research exists. This paper proposes a theory of domestic sovereign default based on distributional incentives affecting the welfare of risk-averse debt- and non-debt holders. A utilitarian government cannot sustain debt if default is costless. If default is costly, debt with default risk is sustainable, and debt falls as concentration of debt ownership rises. A government favoring bond holders can also sustain debt, with debt rising as ownership becomes more concentrated. These results are robust to adding foreign investors, redistributive taxes, or a second asset.
Keywords: sovereign default; debt sustainability; distributional incentives
JEL Codes: E44; E6; F34; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| cost of default (G33) | sustainability of government debt (H63) |
| costly default (G33) | government decision to repay (H63) |
| political bias favoring bondholders (H74) | levels of government debt (H63) |
| ownership concentration (G32) | sustainability of government debt (H63) |
| foreign investors (F21) | dynamics of domestic debt sustainability (H63) |