Distributional Incentives in an Equilibrium Model of Domestic Sovereign Default

Pablo D'Erasmo, Enrique G. Mendoza

NBER Working Paper No. 19477
Issued in September 2013
NBER Program(s):   IFM   ME   PE

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.

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This paper was revised on July 15, 2015

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Document Object Identifier (DOI): 10.3386/w19477

Published: Distributional Incentives in an Equilibrium Model of Domestic Sovereign Default, Pablo D'Erasmo, Enrique G. Mendoza. in Sovereign Debt and Financial Crises, Kalemli-Ozcan, Reinhart, and Rogoff. 2016

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