Sovereign Debt and Structural Reforms
Andreas Müller, Kjetil Storesletten, Fabrizio Zilibotti
American Economic Review · 2019 · Volume 109 · Issue 12
Abstract
We construct a dynamic theory of sovereign debt and structural reforms with limited enforcement and moral hazard. A sovereign country in recession wishes to smooth consumption. It can also undertake costly reforms to speed up recovery. The sovereign can renege on contracts by suffering a stochastic cost. The constrained optimal allocation (COA) prescribes imperfect insurance with nonmonotonic dynamics for consumption and effort. The COA is decentralized by a competitive equilibrium with markets for renegotiable GDP-linked one-period debt. The equilibrium features debt overhang: reform effort decreases in a high debt range. We also consider environments with less complete markets.
Keywords
Asymmetric and Private Information, Mechanism Design, Macroeconomics: Consumption, Saving, Wealth, Macroeconomics: Production, Business Fluctuations, Cycles, International Lending and Debt Problems, National Debt, Debt Management, Sovereign Debt
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