Distributional Incentives in an Equilibrium Model of Domestic Sovereign Default

72 Pages Posted: 10 Aug 2016

See all articles by Pablo D'Erasmo

Pablo D'Erasmo

Federal Reserve Banks - Federal Reserve Bank of Philadelphia; University of Maryland - College Park

Enrique G. Mendoza

National Bureau of Economic Research (NBER); University of Pennsylvania

Date Written: 2016-08-09

Abstract

Europe’s debt crisis resembles historical episodes of outright default on domestic public debt about which little research exists. This paper proposes a theory of domestic sovereign default based on distributional incentives affecting the welfare of risk-averse debt and non-debtholders. A utilitarian government cannot sustain debt if default is costless. If default is costly, debt with default risk is sustainable, and debt falls as the concentration of debt ownership rises. A government favoring bondholders can also sustain debt, with debt rising as ownership becomes more concentrated. These results are robust to adding foreign investors, redistributive taxes, or a second asset.

Keywords: Public debt, Sovereign default, European debt crisis

JEL Classification: E44, E6, F34, H63

Suggested Citation

D'Erasmo, Pablo and Mendoza, Enrique G., Distributional Incentives in an Equilibrium Model of Domestic Sovereign Default (2016-08-09). FRB of Philadelphia Working Paper No. 16-23. Available at SSRN: https://ssrn.com/abstract=2820960

Pablo D'Erasmo (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

University of Maryland - College Park ( email )

College Park, MD 20742
United States

Enrique G. Mendoza

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of Pennsylvania ( email )

Philadelphia, PA 19104
United States

HOME PAGE: http://www.sas.upenn.edu/~egme/index.html

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