A General Equilibrium Model of Sovereign Default and Business Cycles

July 1, 2011

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Zhanwei Z. Yue, and Enrique G. Mendoza A General Equilibrium Model of Sovereign Default and Business Cycles, (USA: International Monetary Fund, 2011) accessed December 26, 2024

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.

Subject: Debt default, External debt, Labor, Labor supply, Production, Public debt, Total factor productivity

Keywords: Africa, Business cycles, Country default, Country risk, Credit market, Debt default, Debt ratio, Default event, Default frequency, Default incentive, Default probability, Default punishment, Eastern Europe, External debt, Labor supply, Result default, Sensitivity analysis, Sovereign default, Total factor productivity, Transmission mechanism, Utility function, Western Europe, Western Hemisphere, Working capital, WP

Publication Details

Pages:

55
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2011/166
Stock No:

WPIEA2011166
ISBN:

9781462302222
ISSN:

1018-5941

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