Distributional Incentives in an Equilibrium Model of Domestic Sovereign Default. Issue 1 (1st February 2016)

• Record Type: Journal Article
• Authors: D'Erasmo, Pablo; Mendoza, Enrique G.
• Is Part Of: Journal of the European Economic Association. Volume 14:Issue 1(2016:Feb.)
• Page Start: 7
• Page End: 44
• Publication Date: 2016-02-01
• Subjects: E6 -- E44 -- F34 -- H63; Economics -- Periodicals; Économie politique -- Périodiques; Science économique; Périodique électronique (Descripteur de forme); Ressource Internet (Descripteur de forme); 330
• DOI: 10.1111/jeea.12168
• Languages: English
• ISSNs: 1542-4766

Abstract

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 nondebtholders. 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 bond holders 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.