## Macroeconomic Effects of Sovereign Restructuring in a Monetary Union: A Model-based Approach

_IMF Working Papers, December 26, 2013_

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## Bibliographic details
- Authors: Lorenzo Forni, Massimiliano Pisani
- Published: December 26, 2013
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781484333754.001

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### Summary
- Objective: Assess the macroeconomic effects of a sovereign restructuring in a small economy belonging to a monetary union by simulating a dynamic general equilibrium model.
- Three key modeling assumptions (in line with empirical evidence):
  - Sovereign debt is held by domestic agents and by agents in the rest of the monetary union.
  - After the restructuring the sovereign borrowing rate increases and its increase is fully transmitted to the borrowing rate paid by the domestic agents.
  - The government cannot discriminate between domestic and foreign agents when restructuring.
- Main result: Macroeconomic effects of the restructuring depend on:
  - (a) the share of sovereign bonds held by residents in the country as compared to that held by foreign residents,
  - (b) the increase in the spread paid by domestic agents, and
  - (c) its net foreign asset position at the moment of the restructuring.
- Quantitative implication: Sovereign restructuring implies persistent reductions of output, consumption and investment; these reductions can be large, particularly if:
  - the share of public debt held domestically is large,
  - private foreign debt is high, and
  - the spread paid by the government and the households does increase.

### Model assumptions and transmission mechanisms
- Debt ownership composition:
  - Explicit modeling of sovereign bonds held domestically and by residents of the rest of the monetary union.
- Interest rate transmission:
  - Increase in sovereign borrowing rate is fully passed through to domestic agents' borrowing rates.
- Non-discrimination in restructuring:
  - Government cannot target restructuring measures differently for domestic vs. foreign bondholders.

### Key findings and scenarios
- Determinants of macroeconomic impact:
  - Share of sovereign bonds held by residents vs. foreign residents.
  - Magnitude of the spread increase paid by domestic agents.
  - Net foreign asset position at the time of restructuring.
- Dynamic outcomes:
  - Persistent reductions in output.
  - Persistent reductions in consumption.
  - Persistent reductions in investment.
- Conditions amplifying adverse effects:
  - Large share of public debt held domestically.
  - High levels of private foreign debt.
  - Increases in spreads paid by government and households.

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