Internal Debt Crises and Sovereign Defaults

39 Pages Posted: 13 Feb 2008 Last revised: 11 Sep 2010

See all articles by Cristina Arellano

Cristina Arellano

University of Minnesota - Twin Cities - Department of Economics

Narayana Kocherlakota

University of Minnesota - Twin Cities - Department of Economics

Date Written: February 2008

Abstract

In this paper, we use data from developing countries to argue that sovereign defaults are often caused by fiscal pressures generated by large-scale domestic defaults. We argue that these systemic domestic defaults are caused by shocks best interpreted as being non-fundamental. We construct a model that is consistent with these observations. The key ingredient of the model is that it is impossible to liquidate large amounts of entrepreneurial assets. This restriction generates the possibility of a domestic coordinated default crisis, in which domestic borrowers find it optimal to default because all other borrowers are also defaulting. We conclude that avoiding sovereign defaults requires better internal institutions, not better external ones.

Suggested Citation

Arellano, Cristina and Kocherlakota, Narayana, Internal Debt Crises and Sovereign Defaults (February 2008). NBER Working Paper No. w13794. Available at SSRN: https://ssrn.com/abstract=1092842

Cristina Arellano (Contact Author)

University of Minnesota - Twin Cities - Department of Economics ( email )

271 19th Avenue South
Minneapolis, MN 55455
United States
612-6250511 (Phone)

HOME PAGE: http://www.econ.umn.edu/~arellano/

Narayana Kocherlakota

University of Minnesota - Twin Cities - Department of Economics ( email )

271 19th Avenue South
Minneapolis, MN 55455
United States
612-625-5318 (Phone)
612-624-0209 (Fax)

HOME PAGE: http://www.econ.umn.edu/~nkocher/

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