Domestic Policies and Sovereign Default

RePEc Short ID: pko790
ORCID iD: 0000-0001-8464-2470

Espino, Emilio; Kozlowski, Julian; Martin, Fernando M.; Sanchez, Juan M.

doi:10.20955/wp.2020.017

Working Paper Revision

Domestic Policies and Sovereign Default

Abstract: A model with two essential elements, sovereign default and distortionary fiscal and monetary policies, explains the interaction between sovereign debt, default risk and inflation in emerging countries. We derive conditions under which monetary policy is actively used to support fiscal policy and characterize the intertemporal tradeoffs that determine the choice of debt. We show that in response to adverse shocks to the terms of trade or productivity, governments reduce debt and deficits, and increase inflation and currency depreciation rates, matching the patterns observed in the data for emerging economies.

Keywords: Limited commitment; Sovereign Debt; Inflation; Fiscal Policy; Monetary Policy; Emerging Markets; Latin America;

JEL Classification: E52; E62; F34; F41; G15;

https://doi.org/10.20955/wp.2020.017