A General Equilibrium Model of Sovereign Default and Business Cycles

Author/Editor:

Zhanwei Z. Yue ; Enrique G. Mendoza

Publication Date:

July 1, 2011

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

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-noc 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 on public and private obligations occurs simultaneously. The model explains several features of cyclical dynamics around 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 deraults, countercyclical spreads, high debt ratios, and key business cycle moments.

Series:

Working Paper No. 11/166

Subject:

English

Publication Date:

July 1, 2011

ISBN/ISSN:

9781462302222/1018-5941

Stock No:

WPIEA2011166

Format:

Paper

Pages:

55

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