A General Equilibrium Model of Sovereign Default and Business Cycles

By Enrique G. Mendoza, Vivian Z. Yue. Social Science Research Network, 2011

511 citations recorded by the source corpus.

Emerging markets business cycle models treat default risk as part of an exogenous interest rate on working capital, while sovereign default models treat income fluctuations as an exogenous endowment process with ad-hoc default costs. We propose instead a general equilibrium model of both sovereign default and business cycles. In the model, some imported inputs require working capital financing; default triggers an efficiency loss as these inputs are replaced by imperfect substitutes; and default on public and private obligations occurs simultaneously. The model explains several features of cyclical dynamics around defaults, countercyclical spreads, high debt ratios, and key business cycle moments.

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Citations in the corpus

Sovereign defaults and banking crises (2018, background): “As in Mendoza and Yue (2012) , the v-shaped recovery of output after a default event is driven by two forces: TFP and re-access to credit.”
The Pass-Through of Sovereign Risk (2016, methodology): “This observation is typically rationalized in the literature via a selection argument: equilibrium models of sovereign defaults predict that incentives for the government to renege on debt are high in bad economic times, see Arellano (2008) and Mendoza and Yue (2012) for example.”
External Liabilities and Crises (2013, unknown): “FDI liability outliers Variables 1970–2011 1970–2011 1970–2011 1970–2010 1970–2010 1970–2006 1970–2006 Net external debt assets/GDP −1.22⁎⁎ −2.10⁎⁎⁎ −1.27⁎⁎ −0.13 −0.68⁎ −1.85⁎⁎⁎ −1.68⁎⁎⁎ (0.50) (0.38) (0.53) (0.24) (0.37) (0.61) (0.58) Net ext. portfolio equity/GDP 0.53 1.12 1.66 0.97 1.22 −0.43 −0”
Sovereign Risk and Belief-Driven Fluctuations in the Euro Area (2013, methodology): “Conceptually related is the notion that in the case of a sovereign default, the government di- verts funds from the payments made by borrowers; see Mendoza and Yue (2012).”
What is a Sustainable Public Debt (2015, unknown): “…the default cost functions widely used in the external default literature to align default incentives so as to support higher debt ratios and trigger default during recessions (see Arellano (2008) and Mendoza and Yue (2012)): The default cost is an increasing function of disposable income (y − g1).”
Sovereign Debt Markets in Turbulent Times: Creditor Discrimination and Crowding-Out Effects (2014, unknown): “More generally, Broner et al. (2013) show that periods of financial turbulence are often accompanied by a reduction in gross capital flows, in which foreigners reduce their purchases of domestic assets and domestic residents reduce their purchases of foreign assets.”
U.S. Monetary Policy and International Risk Spillovers (2019, background): “Contractionary effects also work via imported intermediate inputs that are used in the production and will be more expensive after a depreciation as shown by Mendoza and Yue (2012) and Gopinath and Neiman (2014).”
International Reserves and Rollover Risk (2013, unknown): “Mexico is a common reference for studies on emerging economies because its business cycle displays the same properties that are observed in other emerging economies (Aguiar and Gopinath, 2007; Neumeyer and Perri, 2005; and Uribe and Yue, 2006), and it is often used in the quantitative sovereign defa”
Inspecting the Mechanism: Leverage and the Great Recession in the Eurozone (2017, background): “Our approach is also consistent with the lending constraints view of Justiniano, Primiceri, and Tambalotti (2015). can be explained by multiple equilibria in international financial markets with transaction costs, as in Martin and Rey (2006).”