Domestic Costs of Default: Interactions and Policy Implications




Beverinotti, Javier H.

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Since the 1990s, economic crises are characterized by the joint occurrence of banking crises and debt restructuring. The literature has mostly focused on two types of costs associated with debt restructuring: reputation effects and direct sanctions. However, defaults also involve costs to the domestic economy. For instance, this occurs since the local banking sector is usually a major holder of government bonds. Then, defaults could be accompanied with a crisis in the banking sector and a reduction in the credit available for the private sector. This dissertation presents a study of the exposure of local financial intermediaries to episodes of debt restructuring, with special emphasis on the consequences to the private sector. Ultimately, the objective of this dissertation is to understand the effects of the governments’ decisions to default or not. In chapter 2, we’ll focus on a static model to study the interactions between the sectors of the economy and the role that financial institutions play for the real economy in this context. Latter, we’ll analyze these interactions with a dynamic model. This new model will explain better the interactions and sequence of events during recent and past sovereign debt crises. The dissertation then follows with a chapter of case studies where well-known debt episodes will be explained using the analytical tools developed in previous chapters. Understanding the basics of the interactions between sectors of the economy will help us recognize the main effects that defaults cause to the real economy. Also, it will help us generate policies to mitigate risks and reduce costs attached to the new features of financial crises observed during the last few years. In Chapter 5 we will conclude the dissertation with some policy recommendations and a summary of the main contributions.



Sovereign debt, Costs of default, Default, Interactions, Dynamic model