Working Paper: NBER ID: w27275
Authors: Cristina Arellano; Yan Bai; Gabriel P. Mihalache
Abstract: Emerging markets have experienced large human and economic costs from COVID-19, and their tight fiscal space has limited the support extended to their citizens. We study the impact of an epidemic on economic and health outcomes by integrating epidemiological dynamics into a sovereign default model. The sovereign’s option to default tightens fiscal space and results in an epidemic with limited mitigation and depressed consumption. A quantitative analysis of our model accounts well for the dynamics of fatalities, social distancing, consumption, sovereign debt, and spreads in Latin America. We find that because of default risk, the welfare cost of the pandemic is about a third higher than it is in a version of the model with perfect financial markets. We study debt relief programs and find a compelling case for their implementation. These programs deliver large social gains, improving health and economic outcomes for the country at no cost to international lenders or financial institutions.
Keywords: COVID-19; emerging markets; sovereign debt; epidemiological dynamics; debt relief
JEL Codes: E52; F34; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Default Risk (G33) | Fiscal Response (E62) |
| Fiscal Response (E62) | Health Outcomes (I14) |
| Default Risk (G33) | Consumption (E21) |
| Consumption (E21) | Health Outcomes (I14) |
| Default Risk (G33) | Welfare Cost of Pandemic (D69) |
| Debt Relief Programs (F34) | Welfare Outcomes (I38) |
| Default Risk (G33) | Epidemic Mitigation (H12) |
| Epidemic Mitigation (H12) | Health Outcomes (I14) |
| Default Risk (G33) | Social Distancing (Z13) |