Sovereign Debt and Structural Reforms

Kjetil Storesletten, Fabrizio Zilibotti and Andreas Müller

American Economic Review

Front page of journal American Economic Review

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Published in:

American Economic Review​​​​​​​, December 2019, Volume 109

Link to the paper

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.

Published Dec. 30, 2019 10:03 AM - Last modified Oct. 1, 2020 10:46 AM