Sovereign Debt and Structural Reforms
- (pp. 4220-59)
Abstract
We construct a dynamic theory of sovereign debt and structural reforms with limited enforcement and moral hazard. A sovereign country in recession wishes to smooth consumption. It can also undertake costly reforms to speed up recovery. The sovereign can renege on contracts by suffering a stochastic cost. The constrained optimal allocation (COA) prescribes imperfect insurance with nonmonotonic dynamics for consumption and effort. The COA is decentralized by a competitive equilibrium with markets for renegotiable GDP-linked one-period debt. The equilibrium features debt overhang: reform effort decreases in a high debt range. We also consider environments with less complete markets.Citation
Müller, Andreas, Kjetil Storesletten, and Fabrizio Zilibotti. 2019. "Sovereign Debt and Structural Reforms." American Economic Review, 109 (12): 4220-59. DOI: 10.1257/aer.20161457Additional Materials
JEL Classification
- D82 Asymmetric and Private Information; Mechanism Design
- E21 Macroeconomics: Consumption; Saving; Wealth
- E23 Macroeconomics: Production
- E32 Business Fluctuations; Cycles
- F34 International Lending and Debt Problems
- H63 National Debt; Debt Management; Sovereign Debt