Working Paper: NBER ID: w25031
Authors: Sergio Rebelo; Neng Wang; Jinqiang Yang
Abstract: We propose a model of sovereign debt in which countries vary in their level of financial development, defined as the extent to which they can issue debt denominated in domestic currency in international capital markets. We show that low levels of financial development generate the “debt intolerance” phenomenon that plagues emerging markets: it reduces overall debt capacity, increases credit spreads, and limits the country's ability to smooth consumption.
Keywords: Sovereign debt; Financial development; Emerging markets; Debt intolerance; Rare disasters
JEL Codes: G18; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| low levels of financial development (O16) | debt intolerance (F34) |
| debt intolerance (H74) | reduced overall debt capacity (G32) |
| debt intolerance (F34) | increased credit spreads (G19) |
| low levels of financial development (O16) | reduced overall debt capacity (G32) |
| low levels of financial development (O16) | increased credit spreads (G19) |
| higher financial development (O16) | ability to issue more domestic currency debt (H63) |
| ability to issue more domestic currency debt (H63) | better management of disaster risks (H12) |
| better management of disaster risks (H12) | lower spreads on foreign currency debt (G15) |
| increasing ability to issue domestic currency debt (H63) | improved welfare (I30) |