## IMF Working Paper wpiea2022122 — Selected chapters

## Source details

**Canonical URL:** [IMF Working Paper wpiea2022122 — Selected chapters](https://www.imf.org/-/media/files/publications/wp/2022/english/wpiea2022122-print-pdf.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/wp/2022/english/wpiea2022122-print-pdf.pdf.md)
- [Structured JSON version](/-/media/files/publications/wp/2022/english/wpiea2022122-print-pdf.pdf.json)

---

### 1. Introduction — Nature, objectives, and sovereign debt basics
- Nature and dual perspectives on sovereign debt:
  - Sovereign debt is debt issued by national governments; domestically viewed as safer and more liquid because of the sovereign’s power to tax future income.
  - Sovereign debt facilitates coping with liquidity shocks, consumption smoothing, and realization of investment opportunities.
  - Enforcement difficulties for sovereign debt contracts, especially for foreign-held debt, since foreign courts rarely can force a sovereign to hand over assets located inside its borders.
  - Two contrasting empirical regimes:
    - Advanced countries: large volumes of tradable debt held by domestic residents; default politically costly and rare.
    - Emerging markets and developing countries (EMDEs): weaker political institutions, segmented markets, and greater enforcement challenges.
  - Sovereign’s extraordinary powers: power to tax (supporting safety/liquidity) and power over territory/assets (limiting external enforcement).

- Paper objectives and literature overview:
  - Aim: clarify assumptions and drivers behind the two characterizations of sovereign debt and their implications—benefits of safe sovereign debt and costs of sovereign risk.
  - Reviews literature from the early 1980s onward on sovereign debt held by private creditors, including valuation and sustainability in advanced countries.
  - Structure: unique characteristics of sovereign borrowing; institutional features of sovereign debt markets; uses and implications of default-risk free sovereign debt; causes/costs of default; implications of sovereign risk; strategies for reducing sovereign risk.

- Distinctive features of sovereign borrowing:
  - Common motives with private borrowing: finance long-lived investments; countercyclical borrowing for consumption smoothing and maintaining government services; avoid distortionary tax volatility (Barro, 1979).
  - When sovereign debt is default-risk free:
    - Safer and more liquid than private debt because sovereigns back debt with future tax power.
    - Governments issuing “safe” debt may sustain positive debt without generating primary surpluses to repay it.
  - When sovereign debt is not safe:
    - Enforcement problems acute for foreign-held debt; foreign courts’ remedies limited because most assets lie inside sovereign borders (Hatchondo and Martinez (2011); Wright (2002)).
  - Political economy differences: politicians may not internalize future costs; governments may borrow strategically to bind future governments (Alesina and Tabellini, 2005; Persson and Svensson, 1989).
  - Conclusion: benefits or problems depend on issuer institutions, creditor identity, domestic market liquidity, and domestic–international market integration.

- Sovereign bond market basics:
  - Size and history:
    - Sovereign debt market is the oldest and largest bond market.
    - As of end-2018, the amount of global debt securities issued by general government exceeded $45 trillion (BIS, 2019).
    - Securities-level data exist from the 1800s for advanced economies; Meyer, Reinhart, and Trebesch (2021) compile a database covering foreign-currency government bonds traded in London and New York since 1815 covering 91 countries.
  - Market structure and instruments:
    - Primary markets (auctions—Dutch style or minimum-price offering—or syndication/underwriting/tap sales) and secondary markets interact; higher secondary market liquidity supports primary market participation and vice versa (Passadore and Xu, 2020).
    - Bonds differ by governing law, currency denomination, maturity, amortization, interest structure, nominal or CPI-indexed, and non-financial provisions. Market standards change slowly (Gelpern, Gulati and Zettelmeyer 2019).
    - Advanced countries almost always issue under domestic law; EMDEs shifted domestic-debt share from about 30 percent to 46 percent between 2000 and 2020 (IMF 2021).
  - Currency composition:
    - Most advanced economies issue in their own currencies.
    - EMDEs often issue in foreign currencies; most foreign-currency debt is denominated in US dollars (Arsanalp et al, 2019).
  - Investor base and tradability:
    - Secondary trading makes holders hard to track; non-residents can participate in domestic markets and vice versa.
    - OECD (2019) notes increasing roles of domestic and foreign central banks and institutional investors in the 2010s; domestic central bank demand may crowd out domestic private bank demand.

- Safe sovereign debt: liquidity services and valuation implications:
  - IGBC in complete markets with no private borrowing constraints:
    - Market value of outstanding debt must equal the net present value of expected future primary surpluses calculated using stochastic discount factors (Bohn, 1995). Notation: value of debt stock = E{PV(future primary surpluses)}.
  - When private agents are borrowing constrained:
    - Safe sovereign debt provides liquidity that functions like loosening of borrowing constraints (Aiyagari and McGrattan, 1998) and can be essential for realizing productive investments (Woodford 1990).
  - Expanded IGBC when sovereign debt provides liquidity services:
    - value of debt stock = E{PV(future primary surpluses)} + E{PV(future service flow)}.
    - Positive debt levels could be sustainable even without future primary surpluses because of the service flow; risk of “overmining” and loss of safe-asset status (Farhi and Maggiori, 2018).
  - Policy implication:
    - Governments where market value of debt significantly exceeds present value of forecast future primary surpluses should consider managing down debt to reduce risk of disruptive loss of safe-asset status.

### 5. Sovereign debt restructurings and defaults — definitions, mechanics, and costs
- Definitions and stylized facts:
  - Legal default: contractually specified breach—failure to pay scheduled debt service beyond the grace period.
  - Preemptive restructurings: renegotiation before a payment has been missed; post-default restructurings follow missed payments.
  - Credit-rating agencies: define default as a restructuring offer with terms less favorable than the original debt.
  - Empirical patterns:
    - 38 percent of debt restructurings between 1978 and 2010 were preemptive (Asonuma and Trebesch, 2016).
    - Preemptive restructurings average negotiation time: 12 months; post-default restructurings: 60 months.
    - Four main peaks in emerging market defaults in the last 200 years: the 1830s, the 1880s, the 1930–40s, and the 1980s (Mitchener and Trebesch, 2021).
    - Greece in 2012: first advanced country since the 1960s to undergo a deep debt restructuring (Zettelmeyer, Trebesch and Gulati, 2013).

- Restructuring mechanics and haircut measures:
  - Typical restructuring components: combination of lower principal, lower interest payments, and longer maturities (average maturity lengthening: 3.4 years according to Dvorkin et al., 2021).
  - Haircut conventions:
    - HM (market-practitioner): compares present value of new debt with face value of old debt surrendered.
    - HSZ (Sturzenegger and Zettelmeyer): compares present value of new and old (originally promised) payment streams, both evaluated at the exit yield; HSZ tends to deliver lower estimates of investor losses than HM.
  - Empirical haircut facts:
    - Meyer et al. (2021) report an average HSZ of 44 percent across more than 300 sovereign debt crises since 1815.
    - Haircuts typically smaller in preemptive restructurings than in post-default restructurings: 18 vs. 48 percent (Asonuma and Trebesch, 2016).
    - Haircuts larger for short-term debt than for long-term debt (Asonuma et al., 2017).
    - Some HSZ observations can be negative in early crisis stages; total debt repudiation corresponds to HSZ = 100 percent.

- Classes of default costs (Panizza et al., 2009):
  - Financial penalties: higher borrowing costs and/or capital market exclusion.
  - Direct sanctions and trade costs.
  - Reputational spillovers.
  - Domestic financial and political costs.

- Access to and costs of external borrowing:
  - Permanent exclusion is empirically rare; temporary exclusion periods are observed (Eaton and Gersovitz, 1981; Cole et al., 1995).
  - Borrowing-cost effects:
    - Sovereign borrowing costs rise after defaults, but effects are temporary (Özler, 1993; Flandreau and Zumer, 2004).
    - Cruces and Trebesch (2013): a one standard deviation increase in investor losses in the default is associated with a medium-term increase in the costs of borrowing by 120 basis points; effect not detected after about 7 years.
  - Legal enforcement via foreign courts can disrupt cross-border payments and access to international capital markets (example: 2011 New York court decision involving Argentina; Schumacher et al., 2021).

- Direct sanctions and trade costs:
  - Historical interventions included diplomatic dissuasion, withholding official credit, trade sanctions, and in exceptional cases armed interventions (Mitchener and Weidenmier, 2005).
  - Trade disruption empirical evidence: sovereign defaults disrupt international trade (Rose, 2005; Asonuma et al., 2016; Serfaty, 2020).
  - 20th and 21st century defaults rarely lead to trade sanctions; reduced trade finance is a plausible channel (Borensztein and Panizza, 2009).

- Default as negative signal:
  - Default can signal policy preferences or weak fundamentals, leading to capital flight, depressed firm net worth, and reduced investment (Cole and Kehoe, 1998; Sandleris, 2008).
  - Hébert and Schreger (2017): legal rulings that increase default probability caused exchange rate depreciation and decline in Argentine equity, disproportionately hurting foreign-owned firms, exporters, and large firms.

- Domestic financial and political costs:
  - Significant share of sovereign debt issued under domestic jurisdiction and held mainly by residents (Reinhart and Rogoff, 2011; IMF, 2021; Erce et al., 2022).
  - Banks’ exposure to sovereigns is significant (Gennaioli et al., 2018); sovereign default can hurt bank balance sheets, reduce lending, trigger banking crises, and lower activity (Gennaioli et al., 2014).
  - Sovereign risk tightens banks’ funding constraints and is recessionary (Bocola, 2016).
  - Reduction in bank credit to the private sector is an important channel through which debt restructurings hurt the economy (Asonuma et al., 2021).
  - Political consequences: defaults associated with increased probability of job loss by political leaders (Borensztein and Panizza, 2009; Malone, 2011).
  - IMF (2014): debt was often high for long periods before restructurings; 86 percent of sovereigns that restructured between 1980 and 2012 did so more than once.

- Quantifying output cost of sovereign defaults:
  - Measurement challenges: defaults correlated with low growth but causality difficult; output contractions typically precede defaults (Levy Yeyati and Panizza, 2011).
  - Empirical causal estimates:
    - Kuvshinov and Zimmermann (2019): defaults have a large but temporary output cost, peaking at an average of almost 4 percent of GDP after five years, followed by long-run recovery.
    - Marchesi and Masi (2021) using synthetic controls:
      - For defaults on private creditors: default depresses growth by about 1 to 1.8 percentage points per year while the country is in default, but not in the long run.
      - For defaults on the official sector: no impact on growth during default years and appears to raise growth in the long run.
  - Factors amplifying default costs:
    - Higher costs in countries with large banking sectors (Asonuma et al., 2021).
    - Larger output costs if defaults are followed by banking crises (Kuvshinov and Zimmermann, 2017).
    - Preemptive restructurings that avoid default have much lower output costs than post-default restructurings (Asonuma et al., 2016, 2021).
    - “Hard” defaults lead to larger output losses than “soft” defaults (Trebesch and Zabel, 2017).

### 7. When do governments default? — triggers, mechanisms, and macro effects
- Affordability of debt payments (“ability to pay”):
  - Default occurs when costs of defaulting are smaller than costs of servicing debt, often because government resources are low relative to scheduled debt service.
  - Circumstances that depress affordability:
    - Economic downturns:
      - Tomz and Wright (2007): 62 percent of default episodes occurred in years when the output level in the defaulting country was below its trend.
    - Terms of trade shocks:
      - Commodity-exporting emerging economies are sensitive; example: Ecuador default in 1999 after falling commodity prices; oil and bananas together accounted for 59 percent of Ecuadorian exports in 2001.
    - Devaluation of local currency:
      - Foreign-currency debt plus non-tradable revenue base magnifies default risk; exchange rate overvaluation and volatility predict sovereign debt crisis.
    - Contingent liabilities:
      - Materialization of contingent liabilities, including from the banking sector, can damage government capacity to pay.

- High borrowing costs (“ability to pay”):
  - Triggers for higher borrowing costs:
    - Sharp rise in advanced country interest rates:
      - Example: Sharply higher U.S. interest rates in the early 1980s triggered the developing country debt crisis of the 1980s.
    - Collapse in confidence or increase in risk aversion (“debt run”, “sudden stop”):
      - Longstaff et al. (2011): global factors account for 64 percent of the variation in sovereign spreads and on average the risk premium represents about a third of sovereign spreads.

- Political factors (“willingness to pay”):
  - Political turnover or shifts (revolution, coup, election) can change willingness to repay and trigger defaults.
  - Election-related concerns can raise sovereign spreads (example: Brazil around the 2002 presidential election).

- The costs of sovereign default risk on macro dynamics:
  - Emerging economies feature higher volatility of output, real interest rates, and net exports compared with developed economies.
  - Consumption is typically more volatile than income in emerging economies (the reverse in advanced economies).
  - Real interest rates are countercyclical in emerging economies; procyclical in advanced economies.
  - Mechanisms include higher borrowing costs in bad times, procyclical public expenditures, doom loops between sovereigns and banks, and pass-through to private-sector borrowing costs.
  - Possibility of “graduation”: improving institutional quality can enable more countercyclical fiscal policy and reduce crisis severity.

- Why governments choose high and volatile sovereign risk:
  - Time-inconsistency and inability to commit to future repayment and borrowing policies lead rational governments to tolerate high/volatile sovereign risk.
  - Debt dilution problem:
    - Governments issue long-term debt; current government cannot control future issuances; bonds are priced rationally; anticipation of future borrowing raises default risk and lowers current bond prices.
    - Issuing only one-period debt avoids time inconsistency but magnifies roll-over exposure.
  - Market incompleteness and noncontingent bonds prevent tying payments to future income realizations; complete markets with contingent contracts could eliminate most sovereign risk.

### 10. What can be done to mitigate sovereign risk? — policy tools and tradeoffs
- Fiscal frameworks:
  - Fiscal rules can improve commitment and reduce excessive future deficits.
  - Hatchondo et al. (2022a, 2022b):
    - Sovereign spread is better suited than debt levels to serve as a fiscal anchor.
    - A common spread-limit generates significant welfare gains for sets of economies with different levels of debt intolerance.
    - A common debt-limit may fail to generate welfare gains for many economies and may generate welfare losses in some.
    - A simple debt brake rule can achieve 60 percent of the welfare gains obtained with the optimal borrowing path.
  - Policy design considerations:
    - Robust recommendations should acknowledge Knightian uncertainty about an economy’s characteristics.
    - Blanchard et al. (2021) propose replacing numerical debt targets with fiscal standards—qualitative prescriptions with room for judgment.
  - Compliance and enforcement:
    - Independent fiscal councils, fiscal responsibility laws, and automatic sanctioning/enforcement can strengthen frameworks.
  - Contractual/structural options:
    - Proposals to modify sovereign debt contracts to constrain future borrowing (Chatterjee and Eyigungor, 2015; Hatchondo et al., 2016).

- State-contingent debt:
  - Rationale: state-contingent instruments (GDP-indexed bonds, cocos) can reduce costly defaults and support countercyclical policy.
  - Potential benefits:
    - Lower payments when GDP is low, facilitating automatic stabilizers and countercyclical fiscal policy.
    - Diminish fiscal crises for governments facing countercyclical borrowing costs.
  - Theoretical and calibrated model evidence:
    - Hatchondo and Martinez (2012); Borensztein and Mauro (2004); Shiller (1993).
    - Hatchondo et al. (2022) on cocos:
      - Cocos that suspend payments during liquidity shocks reduce defaults triggered by liquidity shocks but increase overall default frequency.
      - Cocos that stipulate a debt write-off when the government faces the shock achieve larger welfare gains by reducing default risk.
  - Empirical/practical obstacles:
    - Use is scarce; recent issuances did not secure reasonable premia (Argentina 2005, Greece 2012, Ukraine 2015).
    - Explanations: issuer myopia (IMF 2017; Benford et al. 2018); moral hazard and misreporting concerns; shallow markets and liquidity premia (Moretti 2020); novelty premia for GDP warrants (Costa et al. 2008; Igan et al. 2021); ambiguity premia from model misspecification (Roch and Roldan 2021).
    - Optimal bond design depends on lenders’ preference for robustness; at calibrated levels of robustness the optimal state-contingent bond provides insurance and avoids jumps in repayments.

- Monetary policy credibility:
  - Original sin and currency denomination:
    - Original sin: inability to borrow abroad in local currency (Eichengreen and Hausmann, 1999).
    - Hausmann (2003): original sin raises credit risk via real exchange rate volatility.
  - Link to monetary policy credibility:
    - Lack of credible and independent monetary policy induces borrowers to prefer foreign-currency debt (Jeanne 2003; Rajan and Tokatlidis 2005).
    - Du et al. (2020): lower commitment to inflation leads to resorting to inflation more often, making local-currency debt riskier.
    - Aguiar et al. (2013): a range of moderate inflation credibility makes domestic currency bonds strictly preferable for intermediate debt levels.
  - Monetary union and independence:
    - Bianchi and Mondragon (2022): lack of monetary policy independence increases sovereign default risk by making countries more vulnerable to rollover crises.
  - Additional channel — cyclical insurance properties:
    - Credible central banks lowering interest rates in recessions generate capital gains for domestic holders of sovereign debt, turning government debt into a “negative beta” asset (Brunnermeier et al. 2021; Cochrane 2021).
    - Only central banks that need not worry about de-anchoring inflation expectations can provide this insurance.
  - Policy implications:
    - Credible and independent monetary policy functions like a fiscal asset (Willems and Zettelmeyer 2022).
    - Essential for development of local-currency debt markets, reducing original sin premia and rollover-crisis premia, contributing to market liquidity and insurance value of sovereign debt.
    - Steps: give central banks more independence and adopt inflation-targeting frameworks to de-risk debt and establish it as a safe asset.

### Appendix Table 1 — Business cycles in emerging and developed economies (summary observations)
- Data summary:
  - Quarterly official data (1983-2018). Variables include R (real interest rates, in percentage points), NX (net exports), PC (private consumption), TC (total consumption), INV (investment), EMP (employment), HRS (total hours). All series except NX and R in logs; series Hodrick–Prescott filtered.

- Selected numeric highlights (percent standard deviations and correlations preserved as in source):
  - Emerging economies average standard deviations: GDP 2.45, R 3.23, NX 1.55, PC 1.11, TC 1.31, INV 3.72, EMP 0.54, HRS 0.78.
  - Developed economies average standard deviations: GDP 1.29, R 1.25, NX 0.96, PC 0.85, TC 0.65, INV 4.13, EMP 1.20, HRS 1.11.
  - Tomz and Wright (2007) statistic reiterated: 62 percent of default episodes occurred in years when output was below trend.
  - Example export concentration: oil and bananas together accounted for 59 percent of Ecuadorian exports in 2001.
  - Cruces and Trebesch (2013) finding: one standard deviation increase in investor losses associated with a medium-term borrowing-cost increase of 120 basis points; effect fades after about 7 years.
  - Meyer et al. (2021): average HSZ haircut of 44 percent across more than 300 crises since 1815.
  - Average peak output cost from Kuvshinov and Zimmermann (2019): almost 4 percent of GDP after five years following default.
  - Preemptive vs. post-default haircuts: 18 vs. 48 percent (Asonuma and Trebesch, 2016).
  - Simple debt brake rule can achieve 60 percent of welfare gains relative to optimal borrowing path (Hatchondo et al.).

*Source: wpiea2022122-print-pdf — Extracted chapters 1, 5, 7, 10, Appendix Table 1*

### 1. Introduction

### 1. Introduction

### Nature and dual perspectives on sovereign debt
- Sovereign debt is debt issued by national governments and is often viewed domestically as safer and more liquid than privately issued debt because of the sovereign’s power to tax future income.
- Sovereign debt facilitates:
  - coping with liquidity shocks,
  - consumption smoothing,
  - realization of investment opportunities.
- An alternative perspective stresses enforcement difficulties for sovereign debt contracts, especially for debt held by foreign investors, because foreign courts rarely can force a sovereign to hand over assets located inside its borders.
- Two contrasting empirical regimes:
  - Advanced countries: large volumes of tradable debt held by domestic residents; default politically costly and rare.
  - Emerging markets and developing countries: weaker political institutions, segmented markets, and greater enforcement challenges.
- Both perspectives reflect the sovereign’s extraordinary powers: power to tax (supporting safety/liquidity) and power over territory/assets (limiting external enforcement).

### Paper objectives and literature overview
- Aim: clarify assumptions and drivers behind both characterizations of sovereign debt and their implications—benefits of safe sovereign debt and costs of sovereign risk.
- Reviews literature from early 1980s onward on sovereign debt held by private creditors:
  - Initial focus: why externally held sovereign debt can exist and costs of default.
  - More recent work: measuring default costs, disentangling default costs from output dislocations that induce defaults, studying how sovereign risk alters macroeconomic properties in emerging markets, and recent work on valuation and sustainability of sovereign debt in advanced countries.
- Structure summary (as presented in the source):
  - Unique characteristics of sovereign borrowing;
  - Institutional features of sovereign debt markets;
  - Uses and implications of default-risk free sovereign debt;
  - Core questions: costs and causes of default;
  - Implications of sovereign risk (the shadow of possible default);
  - Strategies for reducing sovereign risk.

### Distinctive features of sovereign borrowing
- Common motives with private borrowing:
  - Finance long-lived investments;
  - Countercyclical borrowing for consumption smoothing and maintaining government services (e.g., law enforcement, public health, public education);
  - Avoid distortionary tax volatility (Barro, 1979).
- Distinctive features that alter costs and default economics:
  - When sovereign debt is default-risk free (empirically relevant in some countries), it is both safer and more liquid than private debt because sovereigns back debt with future tax power.
  - Consequence: governments that can issue “safe” debt may sustain positive debt without generating primary surpluses to repay it, as investors value the safety/liquidity.
  - When sovereign debt is not safe (common in EMDEs and crisis-hit advanced countries), enforcement problems are acute for foreign-held debt; foreign courts can order attachment of sovereign assets but success is limited since most assets lie inside sovereign borders (Hatchondo and Martinez (2011); Wright (2002)).
  - Political economy differences: politicians may not internalize future costs of issuing debt; governments may borrow strategically to bind future governments (Alesina and Tabellini, 2005; Persson and Svensson, 1989).
- Conclusion: whether sovereign debt is beneficial or problematic depends on issuer institutions, creditor identity, domestic market liquidity, and domestic–international market integration. Policy may influence these characteristics.

### Sovereign bond market basics
- Size and history:
  - The sovereign debt market is the oldest and largest bond market.
  - As of end-2018, the amount of global debt securities issued by general government exceeded $45 trillion (BIS, 2019).
  - Securities-level data exist from the 1800s for advanced economies; Meyer, Reinhart, and Trebesch (2021) compile a database covering foreign-currency government bonds traded in London and New York since 1815 covering 91 countries.
- Market structure and instruments:
  - Primary markets (auctions—Dutch style or minimum-price offering—or syndication/underwriting/tap sales) and secondary markets interact: higher secondary market liquidity supports primary market participation and vice versa (Passadore and Xu, 2020).
  - Sovereign bonds differ by governing law (domestic or foreign), currency denomination, maturity, amortization, interest structure (floating/fixed), nominal or CPI-indexed, and non-financial provisions (listing requirements; cross-default, acceleration, negative pledge; majority restructuring provisions). Market standards change slowly (Gelpern, Gulati and Zettelmeyer 2019).
  - Advanced countries almost always issue under domestic law; EMDEs have tended to issue under foreign law (New York or English), but the share of domestic debt in total debt of EMDEs rose from about 30 percent to 46 percent between 2000 and 2020 (IMF 2021).
- Currency composition:
  - Most advanced economies issue debt in their own currencies.
  - EMDE governments often issue in foreign currencies; most foreign-currency debt is denominated in US dollars, with Japanese yen, euros, UK sterling, or Swiss francs playing minor roles (Arsanalp et al, 2019).
  - The “original sin” literature (Eichengreen and Hausmann, 1999) studies causes/consequences of foreign currency issuance; some emerging countries have developed local capital markets and issued local-currency bonds (EBRD 2010).
- Investor base and tradability:
  - Secondary market trading makes holders hard to track; non-residents can participate in domestic markets and vice versa, limiting sovereigns’ ability to implement selective defaults (Broner, Martin, and Ventura, 2010).
  - OECD (2019) notes increasing roles of domestic and foreign central banks and institutional investors in the 2010s; domestic central bank demand may crowd out domestic private bank demand.
  - Arslanalp and Tsuda (2014, updated) provide similar investor decompositions for emerging markets.

### Safe sovereign debt: liquidity services and valuation implications
- Focus: economies where investors regard government debt as default-risk free; sovereign debt can provide liquidity services to investors facing borrowing constraints, affecting pricing and sustainability.
- Intertemporal Government Budget Constraint (IGBC) in complete markets with no private borrowing constraints:
  - Market value of outstanding debt must equal the net present value of expected future primary surpluses calculated using stochastic discount factors (Bohn, 1995). Referred to as IGBC: value of debt stock = E{PV(future primary surpluses)}.
  - Use of stochastic discount rates reflects that market value of otherwise default-risk free debt fluctuates, exposing investors to risk.
- When private agents are borrowing constrained (scarce collateral), safe sovereign debt provides liquidity that functions like loosening of borrowing constraints (Aiyagari and McGrattan, 1998) and can be essential for realizing productive investments (Woodford 1990).
  - Sovereign debt can “crowd in” investment and raise growth via consumption smoothing and facilitating investment—effects independent of government spending financed by debt.
- Private intermediaries may fail to supply aggregate liquidity when liquidity needs are correlated and private borrowing is constrained; government issuance can achieve Pareto improvements by providing sovereign-backed liquidity (Holmstrom and Tirole, 1998).
- Implications for valuation and sustainability:
  - Some authors (Olijslagers et al. (2021); Jiang et al. (2021)) argue a valuation puzzle: inconsistency between high debt levels, persistent primary deficits, and low expected inflation—suggesting IGBC (value of debt stock = E{PV(future primary surpluses)}) is violated and markets must be expecting atypically large future primary surpluses or an unexpected disruptive event that lowers the value of the debt stock.
  - When sovereign debt provides liquidity services, the IGBC acquires an additional term for the present value of the future service flow:
    - value of debt stock = E{PV(future primary surpluses)} + E{PV(future service flow)}.
  - This expanded IGBC implies positive debt levels could be sustainable even without future primary surpluses because of the service flow (sovereigns can “mine a finite bubble”).
  - The expanded IGBC still sets limits on sustainable primary deficits, but these limits are looser. “Overmining”—pushing debt beyond what the expanded IGBC justifies—risks a loss of safe-asset status and a sharp, disruptive tightening of the IGBC (Farhi and Maggiori, 2018).
- Policy implication:
  - Governments for whom the market value of the debt significantly exceeds the present value of forecast future primary surpluses should consider managing down their debt levels to reduce the risk of a disruptive loss of safe-asset status.

*Source: wpiea2022122-print-pdf - 1. Introduction*

### 5. Sovereign debt restructurings and defaults

### 5. Sovereign debt restructurings and defaults

### Definitions, types, and stylized facts
- Sovereign default definitions:
  - Legal default: contractually specified breach—failure to pay scheduled debt service beyond the grace period.
  - Policy/institutional distinction: “preemptive” restructurings (renegotiation before a payment has been missed) vs. “post-default” restructurings.
  - Credit-rating agencies: define default as a restructuring offer with terms less favorable than the original debt.
- Empirical patterns:
  - 38% of debt restructurings between 1978 and 2010 were preemptive (Asonuma and Trebesch, 2016).
  - Preemptive restructurings average negotiation time: 12 months; post-default restructurings: 60 months.
  - Four main peaks in emerging market defaults in the last 200 years: the 1830s, the 1880s, the 1930–40s, and the 1980s (Mitchener and Trebesch, 2021).
  - Greece in 2012: first advanced country since the 1960s to undergo a deep debt restructuring (Zettelmeyer, Trebesch and Gulati, 2013).

### Restructuring mechanics and haircut measures
- Typical restructuring components:
  - Combination of lower principal, lower interest payments, and longer maturities (average maturity lengthening: 3.4 years according to Dvorkin et al., 2021).
- Haircut measurement conventions:
  - HM (market-practitioner convention): compares present value of new debt with face value of old debt surrendered in the restructuring. Justification: in defaults old debt often accelerated so face value equals present value at that moment.
  - HSZ (Sturzenegger and Zettelmeyer convention): compares present value of new and old (originally promised) payment streams, both evaluated at the exit yield. HSZ measures the loss experienced by creditors accepting the restructuring offer relative to the counterfactual of being repaid with the same probability as accepting investors.
  - Empirical note: Because HSZ discounts the face value of old debt using the (fairly high) exit yield, HSZ tends to deliver lower estimates of investor losses than HM.
- Empirical haircut facts:
  - Meyer et al. (2021) report an average HSZ of 44 percent across more than 300 sovereign debt crises since 1815.
  - Haircuts are typically smaller in preemptive restructurings than in post-default restructurings: 18 vs. 48 percent (Asonuma and Trebesch, 2016).
  - Haircuts larger for short-term debt than for long-term debt (Asonuma et al., 2017).
  - Some HSZ observations can be negative in early crisis stages; total debt repudiation corresponds to HSZ = 100 percent.

### Classes of default costs
- Panizza et al. (2009) taxonomy: four classes of costs that deter sovereign default:
  - Financial penalties: higher borrowing costs and/or capital market exclusion.
  - Direct sanctions and trade costs.
  - Reputational spillovers (negative signals about government or economy).
  - Domestic financial and political costs.

### Access to and costs of external borrowing
- Historical enforcement and exclusion:
  - Eaton and Gersovitz (1981): permanent exclusion could deter defaults in theory, but indefinite exclusion is empirically rare.
  - Temporary exclusion periods are observed and can be rationalized (Cole et al. 1995; Kletzer and Wright, 2000; Wright, 2002).
- Borrowing-cost effects:
  - Sovereign borrowing costs rise after defaults, but effects are temporary (Özler, 1993; Flandreau and Zumer, 2004).
  - Cruces and Trebesch (2013): a one standard deviation increase in investor losses in the default is associated with a medium-term increase in the costs of borrowing by 120 basis points. The effect can no longer be detected after about 7 years.
- Legal enforcement via foreign courts:
  - Court orders can interfere with cross-border payments and have been used to pressure debtors (example: 2011 New York court decision involving Argentina).
  - Creditor lawsuits have become increasingly common and can disrupt government access to international capital markets (Schumacher et al., 2021).

### Direct sanctions and trade costs
- Historical state interventions: diplomatic dissuasion, withholding official credit, trade sanctions, and in exceptional cases armed interventions (Mitchener and Weidenmier, 2005 for 1870–1914 examples).
- Trade disruption:
  - Significant evidence that sovereign defaults disrupt international trade (Rose, 2005; Asonuma et al., 2016; Serfaty, 2020).
  - 20th and 21st century defaults rarely lead to trade sanctions; a plausible channel is reduced trade finance (Borensztein and Panizza, 2009).

### Default as a negative signal about government or economy
- Signaling channels and consequences:
  - Default can signal policy preferences or private information about weak economic fundamentals, affecting trust and broader economic relations.
  - Potential consequences include capital flight, depressed firm net worth, and reduced investment (Cole and Kehoe, 1998; Sandleris, 2008).
  - Hébert and Schreger (2017): legal rulings that increase default probability caused exchange rate depreciation and decline in Argentine equity, disproportionately hurting foreign-owned firms, exporters, and large firms.

### Domestic financial and political costs
- Domestic-holder dynamics:
  - A significant share of sovereign debt is issued under domestic jurisdiction and held mainly by residents (Reinhart and Rogoff, 2011; IMF, 2021; Erce et al., 2022).
  - Banks’ exposure to sovereigns is significant (Gennaioli et al., 2018); sovereign default can hurt bank balance sheets, reduce lending, trigger banking crises, and lower activity (Gennaioli et al., 2014).
  - Sovereign risk tightens banks’ funding constraints and is recessionary (Bocola, 2016).
  - Reduction in bank credit to the private sector is an important channel through which debt restructurings hurt the economy (Asonuma et al., 2021).
- Political consequences:
  - Sovereign defaults associated with increased probability of job loss by political leaders (Borensztein and Panizza, 2009; Malone, 2011).
  - Desire to avoid political/domestic financial costs may cause restructurings to be “too little too late” (IMF 2014; Guzman and Stiglitz, 2016).
  - Levy Yeyati and Panizza (2011): default quarter typically coincides with trough of output contraction, suggesting defaults may be inefficiently delayed.
  - IMF (2014): debt was often high for long periods before restructurings; 86 percent of sovereigns that restructured between 1980 and 2012 did so more than once.

### Quantifying the output cost of sovereign defaults
- Measurement challenges:
  - Correlation between default and low growth is evident, but causality is difficult to establish due to reverse causality and confounding factors; output contractions typically precede defaults (Levy Yeyati and Panizza, 2011).
- Empirical estimates of causal output impacts:
  - Kuvshinov and Zimmermann (2019), using inverse propensity score weighting (IPSW): defaults have a large but temporary output cost, peaking at an average of almost 4 percent of GDP after five years, followed by long-run recovery.
  - Marchesi and Masi (2021), using synthetic controls:
    - For defaults on private creditors: default depresses growth by about 1 to 1.8 percentage points per year while the country is in default, but not in the long run.
    - For defaults on the official sector: no impact on growth during default years and appears to raise growth in the long run.
- Factors amplifying default costs:
  - Higher costs in countries with large banking sectors (Asonuma et al., 2021).
  - Larger output costs if defaults are followed by banking crises (Kuvshinov and Zimmermann, 2017).
  - Preemptive restructurings that avoid default have much lower output costs than post-default restructurings (Asonuma et al., 2016, 2021).
  - “Hard” defaults—measured by coerciveness of negotiating tactics or investor losses—lead to larger output losses than “soft” defaults (Trebesch and Zabel, 2017).

*Source: wpiea2022122-print-pdf - 5. Sovereign debt restructurings and defaults*

### 7. When do governments default?

### 7. When do governments default?

### Affordability of debt payments (“ability to pay”)
- Default occurs when the costs of defaulting are smaller than the costs of servicing the debt, often because government resources are low relative to scheduled debt service.
- Circumstances that depress affordability:
  - Economic downturns:
    - Governments tend to default in periods of low growth.
    - Tomz and Wright (2007) report that 62 percent of default episodes occurred in years when the output level in the defaulting country was below its trend.
    - Wars or civil conflicts can trigger collapse of economic activity and increase default risk.
  - Terms of trade shocks:
    - Many emerging economies rely on commodity exports as a source of tax revenue and foreign exchange; terms of trade fluctuations are a significant predictor of sovereign default and interest rate spreads.
    - Example: In Ecuador, falling commodity prices led to a sovereign default in 1999.
    - Oil and bananas together accounted for 59 percent of Ecuadorian exports in 2001.
  - A devaluation of the local currency:
    - When sovereign debt is denominated in foreign currency and revenues rely mainly on non-tradable goods, depreciation damages the government’s ability to afford debt payments.
    - Currency mismatches across banking, corporate, and household sectors can magnify depreciation effects, causing bankruptcies, a drop in investment, and lower government revenue.
    - Exchange rate overvaluation and exchange rate volatility predict sovereign debt crisis; exchange rate fluctuations are significant predictors of crises and fiscal crises often overlap with currency crises.
  - Contingent liabilities:
    - Materialization of contingent liabilities, including from the banking sector, may damage government capacity to pay and increase sovereign risk.
    - Bank and sovereign distress can feed into each other.

### High borrowing costs (“ability to pay”)
- High borrowing costs can trigger default if debt grows faster than revenues and the economy, causing loss of market access.
- Two triggers for higher borrowing costs:
  - A sharp rise in advanced country interest rates:
    - Example: Sharply higher U.S. interest rates in the early 1980s were a main trigger of the developing country debt crisis of the 1980s.
    - Studies document that borrowing costs of developing countries are influenced by U.S. interest rates.
  - A collapse in confidence or increase in risk aversion (“debt run”, “sudden stop”):
    - Self-fulfilling dynamics: expectation of default raises borrowing costs, which raises the cost of repaying and induces default.
    - Sudden stops contributed to the Mexican (1995) debt crisis, the Asian (1997) crisis, the international propagation of the global financial crisis after the collapse of Lehman brothers in September of 2008, the March 2020 tightening of emerging market borrowing conditions, and other episodes.
    - Longstaff et al. (2011) find that global factors account for 64 percent of the variation in sovereign spreads and that on average, the risk premium represents about a third of sovereign spreads.

### Political factors (“willingness to pay”)
- Political turnover and changes in domestic political economy can shift the sovereign’s willingness to pay and trigger defaults.
- Evidence and mechanisms:
  - Government turnover may trigger significant changes in willingness to pay.
  - A solvency crisis can be triggered by shifts in parameters governing willingness to make sacrifices to repay (revolution, coup, election).
  - Election-related concerns can raise sovereign spreads (example: Brazil around the 2002 presidential election).
  - Models show default and post-default market access difficulties may be triggered by political turnover.

### The costs of sovereign default risk
- Sovereign default risk affects macroeconomic dynamics of emerging economies:
  - Emerging economies feature higher volatility of output, real interest rates, and net exports compared with developed economies.
  - Consumption is typically more volatile than income in emerging economies (the reverse in advanced economies).
  - Real interest rates are countercyclical in emerging economies (higher interest in recessions); in advanced economies interest rates are procyclical.
  - Emerging economies also exhibit procyclical government expenditure and countercyclical inflation tax.
- Mechanisms and broader costs:
  - High interest rates reflect compensation for probability of sovereign default; countercyclicality of spreads is consistent with higher default likelihood in bad times.
  - More expensive borrowing in bad times can lower borrowing levels, leading to countercyclical net exports and higher consumption volatility relative to income.
  - Optimal policy responses when borrowing is expensive in bad times may include higher taxes and lower government expenditures, explaining procyclicality of public expenditures and countercyclicality of tax rates.
  - “Doom loops”: feedback between sovereign and banking systems due to bank exposure to sovereign bonds and expectations of bailouts can amplify recessions.
  - Sovereign risk passes through to private-sector borrowing costs, making investment more costly and hurting growth prospects.
- Possibility of “graduation”:
  - Some emerging economies have shifted from procyclical to countercyclical fiscal policy; improving institutional quality is key to conducting more countercyclical fiscal policy and reducing crisis severity.

### Why governments choose high and volatile sovereign risk
- Quantitative-theoretic literature: a rational and benevolent government tolerates high and volatile sovereign risk due to inability to commit to future repayment and borrowing policies.
- Debt dilution problem:
  - Arises because: (i) governments issue long-term debt, (ii) the current government cannot control future governments’ issuances, and (iii) bonds are priced by rational investors.
  - Anticipation of future borrowing increases default risk on current long-term bonds, lowering their price.
  - Current governments would benefit from constraining future borrowing to increase bond prices but typically cannot.
  - Issuing only one-period debt eliminates time inconsistency but magnifies exposure to shifts in borrowing opportunities and adverse income shocks requiring frequent rollovers.
  - Actively managing debt maturity can affect debt prices in a self-defeating way, creating tradeoffs about maturity choice.
- Market incompleteness and noncontingent bonds:
  - With only noncontingent bonds, the government promises the same payment regardless of next-period income; the government tends to default if income realisation is sufficiently low.
  - With complete markets and contingent contracts tying payments to next-period income, uncertainty about repayment could be eliminated and most sovereign risk removed; non-contingent bonds prevent this.

*Source: IMF Working Paper — chapter “7. When do governments default?”*

### 10. What can be done to mitigate sovereign risk?

### 10. What can be done to mitigate sovereign risk?

### Fiscal frameworks
- Fiscal rules can improve commitment to future government borrowing by anchoring expectations about future policy, reducing excessive future deficits, and relaxing current borrowing constraints.
- Hatchondo et al. (2022a, 2022b) findings:
  - The sovereign spread is better suited than debt levels to serve as a fiscal anchor.
  - A common spread-limit generates significant welfare gains for sets of economies with different levels of debt intolerance.
  - A common debt-limit may fail to generate welfare gains for many economies and may generate welfare losses in some.
  - A simple debt brake rule can achieve 60 percent of the welfare gains obtained with the optimal borrowing path. (footnote in source)
- Policy design considerations:
  - Fiscal rules often impose common limits to several economies; in 2014, 48 of the 85 countries with fiscal rules had supranational rules.
  - Robust policy recommendations should acknowledge uncertainty about a single economy’s characteristics (Knightian uncertainty).
  - Blanchard et al. (2021) propose replacing numerical debt targets with fiscal standards—qualitative prescriptions with room for judgment and a process to decide whether standards are met.
- Compliance and enforcement mechanisms that strengthen fiscal frameworks:
  - Independent fiscal councils providing public assessments of fiscal plans and performance, and macroeconomic and budgetary forecasts.
  - Fiscal responsibility laws setting out procedural and transparency requirements.
  - Automatic sanctioning and enforcement procedures complementing fiscal rules.
- Contractual and structural options:
  - Chatterjee and Eyigungor (2015) and Hatchondo et al. (2016) propose modifying sovereign debt contracts to constrain future borrowing.
- Institutional note:
  - IMF (2021b) argue fiscal frameworks provide rules and institutions allowing countries to signal commitments and comply with them.

### State-contingent debt
- Rationale:
  - Incomplete markets and lack of state-contingent debt instruments lead to inefficiencies in sovereign debt models.
  - State-contingent debt instruments are proposed to avoid costly defaults, highlighted after the European sovereign debt crises and the COVID-19 shock.
- Potential benefits of GDP-indexed/state-contingent instruments:
  - Tying sovereign obligations to domestic GDP may:
    - Promise lower payments when GDP is low, facilitating financing of automatic stabilizers and countercyclical fiscal policy.
    - Diminish the likelihood of fiscal crises for governments facing countercyclical borrowing costs.
    - Provide investors with exposure to income growth and protection against inflation (Kamstra and Shiller, 2010).
- Evidence from theoretical and calibrated models:
  - Hatchondo and Martinez (2012); Borensztein and Mauro (2004); Shiller (1993) highlight potential benefits.
  - Hatchondo et al. (2022) on cocos (contingent convertible bonds):
    - Cocos that stipulate suspension of debt payments when the government faces liquidity shocks reduce defaults triggered by liquidity shocks but increase overall default frequency.
    - Cocos that stipulate a debt write-off when the government faces the shock achieve larger welfare gains by reducing default risk.
- Empirical/practical obstacles:
  - Use of state-contingent instruments is scarce; recent practical issuances (Argentina 2005, Greece 2012, Ukraine 2015) did not secure reasonable premia.
  - Suggested explanations:
    - Myopia of issuers who may be out of office before gains materialize (IMF 2017; Benford et al. 2018).
    - Moral hazard and misreporting concerns (Krugman 1988), though these do not seem empirically relevant per source.
    - Shallow markets leading to large liquidity premia (Moretti 2020 finds state-contingent debt still welfare-improving).
    - Large “novelty” premia or residual spreads for GDP warrants (Costa et al. 2008; Igan et al. 2021).
    - Ambiguity premia from lenders’ model misspecification concerns (Roch and Roldan 2021), which can explain much of observed novelty premia for threshold state-contingent bonds.
  - Optimal bond design depends on lenders’ preference for robustness:
    - At calibrated levels of robustness, the optimal state-contingent bond provides insurance to the home country and avoids jumps in repayments as a function of domestic income.
    - The optimal design generates substantial welfare gains, which are decreasing in the level of robustness.

### Monetary policy credibility
- Original sin and currency denomination:
  - Eichengreen and Hausmann (1999) introduced “original sin” to describe inability to borrow abroad in local currency.
  - Hausmann (2003) shows original sin raises credit risk because real exchange rate volatility makes capacity to pay more volatile and tend to depreciate in bad times.
- Link to monetary policy credibility:
  - Lack of credible and independent monetary policy induces borrowers to prefer foreign-currency debt (Jeanne 2003; Rajan and Tokatlidis 2005).
  - Du et al. (2020): governments with lower commitment to inflation resort to inflation more often, making local-currency debt riskier and raising risk premia demanded by lenders.
  - Ottonello and Perez (2019) and Engel and Park (forthcoming): models rationalize foreign-currency issuance as commitment to not partially default the debt with future inflation under monetary discretion.
- Trade-offs and optimal credibility:
  - Aguiar et al. (2013): low commitment to inflation increases vulnerability to rollover crises for domestic currency bonds, but extreme commitment eliminates the option to inflate in a crisis; a range of moderate inflation credibility makes domestic currency bonds strictly preferable for intermediate levels of debt.
- Monetary union and independence:
  - Bianchi and Mondragon (2022): lack of monetary policy independence increases sovereign default risk by making countries more vulnerable to rollover crises; without monetary policy autonomy, a self-fulfilling crisis can generate a recession with nominal rigidities under a fixed exchange rate regime but not with a flexible exchange rate.
- Additional channel: cyclical insurance properties of credible central banks
  - By lowering interest rates in recessions, a credible central bank generates capital gains for domestic holders of sovereign debt when needed most, turning government debt into a “negative beta” asset that helps investors hedge (Brunnermeier et al. 2021; Cochrane 2021).
  - Only central banks that need not worry that expansionary policy will de-anchor inflation expectations can provide this insurance.
- Policy implications:
  - Credible and independent monetary policy functions like a fiscal asset (Willems and Zettelmeyer 2022).
  - It is essential for development of local-currency debt markets, reducing the premium associated with original sin and the premium related to rollover crises.
  - It contributes to market liquidity and boosts the insurance value of holding sovereign debt.
  - Giving central banks more independence and adopting inflation-targeting frameworks are essential steps in de-risking debt and establishing it as a safe asset.

*Source: wpiea2022122-print-pdf - 10. What can be done to mitigate sovereign risk?*

### Part 1), 940–971. https://doi.org/10.1086/260807

### wpiea2022122-print-pdf - Part 1), 940–971. https://doi.org/10.1086/260807

### Major research themes covered
- State-contingent sovereign instruments and GDP-indexed bonds: rationale, design, market liquidity, novelty premia, and historical experiences.
- Sovereign default: costs of default, restructuring processes, haircuts, and domestic-law vs. external-law considerations.
- Sovereign risk pricing and determinants: credit spreads, sovereign credit ratings, volatility, interest-rate dynamics, currency composition of debt, and pass-through of sovereign risk to domestic financial institutions.
- Fiscal policy interactions with sovereign risk: fiscal rules, fiscal stimulus under sovereign risk, procyclicality, fiscal credibility, and fiscal councils.
- Sovereign debt structure and market functioning: maturity, seniority, dilution, long-duration bonds, secondary markets, liquidity premia, and safe-asset roles of government debt.
- Debt dynamics and sustainability: r − g considerations, debt/output ratio drivers, debt intolerance, and rules-of-thumb for crises.
- Macro-financial linkages and crisis dynamics: sudden stops, rollover crises, doom loops between sovereign and financial sector balance sheets, and currency crises.
- Political economy and institutions: constitutions, governance, populism cycles, and the role of underwriters, boilerplate contract terms, and legal protections.
- Historical and empirical perspectives: long-run histories of sovereign borrowing, empirical estimates of default costs, and cross-country determinants of spreads and defaults.

### Methodologies and model approaches represented
- Quantitative general equilibrium and partial-equilibrium models of sovereign default and business cycles.
- Models incorporating heterogeneous borrowers, maturity structure, and investor risk aversion.
- Robust control and uncertainty approaches to sovereign risk.
- Empirical analyses using historical datasets, event studies, and cross-country regressions addressing determinants of sovereign spreads, default episodes, and market liquidity.
- Policy-oriented analytical frameworks examining design and implementation of state-contingent debt instruments and fiscal rules.

### Key policy and analytical topics emphasized
- Design and potential benefits/tradeoffs of GDP-indexed or state-contingent sovereign debt instruments, including impacts on liquidity premia and debt sustainability.
- Strengthening fiscal credibility via fiscal councils, fiscal rules, and institutional arrangements to reduce sovereign spreads and default risk.
- Considerations for sovereign debt restructuring frameworks that account for domestic vs. external debt, contractual terms, and investor protections.
- The interaction between monetary policy credibility, public-debt valuation, and the composition/denomination of sovereign liabilities.
- The importance of debt structure (maturity, seniority, currency composition) for reducing rollover and default risk and for market functioning.

### Recurring empirical and theoretical findings (as reflected by the cited literature)
- Sovereign default imposes measurable costs across macroeconomic and financial channels; these costs influence borrowing terms and restructuring outcomes.
- Market pricing of sovereign risk depends on macro fundamentals, volatility, legal/institutional features, and debt instrument characteristics (maturity, currency, and seniority).
- State-contingent instruments are repeatedly analyzed as a mechanism to align sovereign obligations with economic capacity, though market acceptance, liquidity, and novelty premia are important constraints.
- Interactions between sovereign balance sheets and domestic banks create amplification channels during default or stress episodes (doom loops).
- Empirical work highlights heterogeneous experiences across countries and time, suggesting context-specific policy design is crucial.

*Italicized source: Extracted from the bibliography and reference list in wpiea2022122-print-pdf - Part 1), 940–971. https://doi.org/10.1086/260807*

### 939. https://www.bis.org/publ/work939.htm

### Appendix Table 1. Business cycles in emerging and developed economies

### Data summary
- Sample and frequency: Quarterly official data (1983-2018).
- Variables:
  - R: Real interest rates (in percentage points).
  - NX: Net exports (exports minus imports over GDP).
  - PC: Private consumption.
  - TC: Total consumption (includes private and government consumption, changes in inventories, and statistical discrepancy).
  - INV: Investment (gross fixed capital formation).
  - EMP: Employment (number of workers).
  - HRS: Total hours (number of workers times weekly hours of work per worker).
- Transformation and filtering: All series except net exports and real interest rates are in logs. All series have been Hodrick–Prescott filtered.

### (a) Standard deviations
- Emerging economies (percent standard deviation of GDP, then R, NX, PC, TC, INV, EMP, HRS):
  - Argentina: 3.95 10.13 1.52 1.15 0.99 3.41 - -
  - Brazil: 1.66 1.93 0.91 1.13 1.98 3.22 0.73 1.43
  - Korea: 3.29 1.3 2.6 1.57 1.7 2.53 0.62 0.4
  - Mexico: 2.22 1.68 1.21 1.1 0.88 3.59 0.4 0.53
  - Philippines: 1.1 1.11 1.51 0.68 1.1 5.83 0.42 -
  - Average: 2.45 3.23 1.55 1.11 1.31 3.72 0.54 0.78
- Developed economies (percent standard deviation of GDP, then R, NX, PC, TC, INV, EMP, HRS):
  - Australia: 0.91 1.4 0.86 0.97 0.84 4.68 1.08 1.43
  - Canada: 1.22 1.15 0.67 0.66 0.47 2.97 1.57 0.62
  - Netherlands: 1.17 0.8 1.62 0.84 0.68 6.34 - -
  - New Zealand: 1.62 1.74 1.12 0.98 0.78 3.52 0.83 0.19
  - Sweden: 1.54 1.16 0.54 0.79 0.5 3.13 1.31 2.21
  - Average: 1.29 1.25 0.96 0.85 0.65 4.13 1.20 1.11

### (b) Correlations with GDP
- Emerging economies (correlations of R, NX, PC, TC, INV, EMP, HRS with GDP):
  - Argentina: -0.66 -0.90 0.98 0.97 0.97 - -
  - Brazil: -0.11 -0.68 0.78 0.45 0.90 - -
  - Korea: -0.60 -0.91 0.97 0.93 0.96 0.89 0.37
  - Mexico: -0.24 -0.62 0.93 0.92 0.91 - -
  - Philippines: -0.10 0.16 0.22 0.23 0.65 - -
  - Average: -0.34 -0.59 0.78 0.70 0.88 -0.89 0.37
- Developed economies (correlations of R, NX, PC, TC, INV, EMP, HRS with GDP):
  - Australia: 0.40 -0.45 0.46 0.41 0.77 - -
  - Canada: 0.61 0.00 0.72 0.59 0.73 - -
  - Netherlands: 0.72 -0.05 0.75 0.67 0.40 - -
  - New Zealand: 0.14 -0.11 0.70 0.67 0.63 - -
  - Sweden: 0.37 -0.10 0.65 0.55 0.81 - -
  - Average: 0.45 -0.14 0.66 0.58 0.67 - -

### (c) Correlations with interest rate
- Emerging economies (correlations of NX, PC, TC, INV, EMP, HRS with interest rate):
  - Argentina: -0.9 0.98 0.97 0.97 - -
  - Brazil: -0.68 0.78 0.45 0.9 - -
  - Korea: -0.91 0.97 0.93 0.96 0.89 0.37
  - Mexico: -0.62 0.93 0.92 0.91 - -
  - Philippines: 0.16 0.22 0.23 0.65 - -
  - Average: -0.59 0.78 0.70 0.88 -0.89 0.37
- Developed economies (correlations of NX, PC, TC, INV, EMP, HRS with interest rate):
  - Australia: -0.45 0.46 0.41 0.77 - -
  - Canada: 0.00 0.72 0.59 0.73 - -
  - Netherlands: -0.05 0.75 0.67 0.40 - -
  - New Zealand: -0.11 0.70 0.67 0.63 - -
  - Sweden: -0.10 0.65 0.55 0.81 - -
  - Average: -0.14 0.66 0.58 0.67 - -

### Notes
- Net exports (NX) are exports minus imports over GDP.
- Real interest rates (R) are in percentage points.
- Total consumption (TC) includes private (PC) and government consumption, changes in inventories, and statistical discrepancy.
- Investment (INV) is gross fixed capital formation.
- Employment (EMP) is number of workers, and total hours (HRS) is number of workers times weekly hours of work per worker.

*Sources: Authors’ calculations based on quarterly official data (1983-2018). Sovereign Debt Working Paper No. WP/22/122*

---


_Source: https://www.imf.org/-/media/files/publications/wp/2022/english/wpiea2022122-print-pdf.pdf_