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Sovereign Debt and Structural Reforms

Mueller, Andreas and Storesletten, Kjetil and Zilibotti, Fabrizio (2019) 'Sovereign Debt and Structural Reforms.' The American Economic Review, 109 (12). 4220 - 4259. ISSN 0002-8282

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Abstract

We construct a dynamic theory of sovereign debt and structural reforms with limited enforcement and moral hazard. A sovereign country in recession would like 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 Optimum Allocation (COA) prescribes non-monotonic dynamics for consumption and effort and imperfect risk sharing. 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.

Item Type: Article
Uncontrolled Keywords: Debt Overhang, Default, Dynamic Principal-Agent Model, European Debt Crisis, Markov Equilibrium, Moral hazard, Renegotiation, Risk premia, Sovereign Debt, Structural Reforms
Subjects: H Social Sciences > HB Economic Theory
Divisions: Faculty of Social Sciences > Economics, Department of
Depositing User: Elements
Date Deposited: 04 Jul 2019 14:46
Last Modified: 16 Dec 2019 11:15
URI: http://repository.essex.ac.uk/id/eprint/24888

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