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 non-monotonic 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.
| Original language | English (US) |
|---|---|
| Pages (from-to) | 4220-4259 |
| Number of pages | 40 |
| Journal | American Economic Review |
| Volume | 109 |
| Issue number | 12 |
| DOIs | |
| State | Published - Dec 2019 |
| Externally published | Yes |
Bibliographical note
Funding Information:* Müller: University of Essex, Department of Economics, Wivenhoe Park, Colchester, CO4 3SQ UK (email: andreas.mueller@essex.ac.uk); Storesletten: University of Oslo, Department of Economics, PO Box 1095 Blindern, 0317 Oslo, Norway (email: kjetil.storesletten@econ.uio.no); Zilibotti: Yale University, Department of Economics, PO Box 208268, New Haven, CT 06520 (email: fabrizio.zilibotti@yale.edu). Mark Aguiar was the coeditor for this article. We would like to thank the editor, three referees, Árpad Ábraham, Manuel Amador, George-Marios Angeletos, Cristina Arellano, Adrien Auclert, Marco Bassetto, Tobias Broer, Fernando Broner, Alessandro Dovis, Jonathan Eaton, John Geneakoplos, Marina Halac, Patrick Kehoe, Enrique Mendoza, Juan-Pablo Nicolini, Ugo Panizza, Victor Ríos-Rull, Ctirad Slavík, Aleh Tsyvinski, Harald Uhlig, Jaume Ventura, Christopher Winter, Tim Worrall, and seminar participants at the Annual Meeting of the Swiss Society of Economics and Statistics, Barcelona GSE Summer Forum, Brown University, CEMFI, Columbia University, CERGE-EI, CREi, ECB conference: Public debt, fiscal policy and EMU deepening, EIEF Political Economy Workshop, ESSIM 2016, European University Institute, Goethe University Frankfurt, Graduate Institute of Geneva, Humboldt University, Istanbul School of Central Banking, LMU Munich, NORMAC, Oxford, Royal Holloway, Swiss National Bank, Università Cà Foscari, Universitat Autònoma Barcelona, University College London, University of Cambridge, University of Essex, University of Konstanz, University of Mannheim, University of Oslo, University of Oxford, University of Pennsylvania, University of Padua, University of Toronto, and Yale University. We acknowledge support from the European Research Council (ERC Advanced Grant IPCDP-324085). The authors declare that they have no relevant or material financial interests that relate to the research described in this paper.
Funding Information:
Mark Aguiar was the coeditor for this article. We would like to thank the editor, three referees, Árpad Ábraham, Manuel Amador, George-Marios Angeletos, Cristina Arellano, Adrien Auclert, Marco Bassetto, Tobias Broer, Fernando Broner, Alessandro Dovis, Jonathan Eaton, John Geneakoplos, Marina Halac, Patrick Kehoe, Enrique Mendoza, Juan-Pablo Nicolini, Ugo Panizza, Victor Ríos-Rull, Ctirad Slavík, Aleh Tsyvinski, Harald Uhlig, Jaume Ventura, Christopher Winter, Tim Worrall, and seminar participants at the Annual Meeting of the Swiss Society of Economics and Statistics, Barcelona GSE Summer Forum, Brown University, CEMFI, Columbia University, CERGE-EI, CREi, ECB conference: Public debt, fiscal policy and EMU deepening, EIEF Political Economy Workshop, ESSIM 2016, European University Institute, Goethe University Frankfurt, Graduate Institute of Geneva, Humboldt University, Istanbul School of Central Banking, LMU Munich, NORMAC, Oxford, Royal Holloway, Swiss National Bank, Università Cà Foscari, Universitat Autònoma Barcelona, University College London, University of Cambridge, University of Essex, University of Konstanz, University of Mannheim, University of Oslo, University of Oxford, University of Pennsylvania, University of Padua, University of Toronto, and Yale University. We acknowledge support from the European Research Council (ERC Advanced Grant IPCDP-324085). The authors declare that they have no relevant or material financial interests that relate to the research described in this paper.
Publisher Copyright:
© 2019 American Economic Association. All rights reserved.