The Twin Ds: Optimal Default and Devaluation

55 Pages Posted: 24 Jul 2014

See all articles by Seunghoon Na

Seunghoon Na

Purdue University - Department of Economics

Stephanie Schmitt-Grohé

Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Martín Uribe

Columbia University - Graduate School of Arts and Sciences - Department of Economics; National Bureau of Economic Research (NBER)

Vivian Z. Yue

Emory University; Federal Reserve Bank of Atlanta

Multiple version iconThere are 3 versions of this paper

Date Written: July 2014

Abstract

A salient characteristic of sovereign defaults is that they are typically accompanied by large devaluations. This paper presents new evidence of this empirical regularity known as the Twin Ds and proposes a model that rationalizes it as an optimal policy outcome. The model combines limited enforcement of debt contracts and downward nominal wage rigidity. Under optimal policy, default is shown to occur during con- tractions. The role of default is to free up resources for domestic absorption, and the role of exchange-rate devaluation is to lower the real value of wages, thereby reducing involuntary unemployment.

Suggested Citation

Na, Seunghoon and Schmitt-Grohe, Stephanie and Uribe, Martin and Yue, Vivian, The Twin Ds: Optimal Default and Devaluation (July 2014). NBER Working Paper No. w20314, Available at SSRN: https://ssrn.com/abstract=2471207

Seunghoon Na (Contact Author)

Purdue University - Department of Economics ( email )

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Stephanie Schmitt-Grohe

Centre for Economic Policy Research (CEPR) ( email )

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National Bureau of Economic Research (NBER)

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Martin Uribe

Columbia University - Graduate School of Arts and Sciences - Department of Economics ( email )

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Vivian Yue

Emory University ( email )

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