Open AccessDISTRIBUTIONAL INCENTIVES IN AN EQUILIBRIUM MODEL OF DOMESTIC SOVEREIGN DEFAULT
Author(s) -
D'Erasmo Pablo,
Mendoza Enrique G.
Publication year - 2016
Publication title -
journal of the european economic association
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 7.792
H-Index - 93
eISSN - 1542-4774
pISSN - 1542-4766
DOI - 10.1111/jeea.12168
Subject(s) - incentive , economics , sovereign default , sovereignty , monetary economics , general equilibrium theory , default , microeconomics , finance , sovereign debt , politics , political science , law
Europe's debt crisis resembles historical episodes of outright default on domestic public debt about which little research exists. This paper proposes a theory of domestic sovereign default based on distributional incentives affecting the welfare of risk‐averse debt and nondebtholders. A utilitarian government cannot sustain debt if default is costless. If default is costly, debt with default risk is sustainable, and debt falls as the concentration of debt ownership rises. A government favoring bond holders can also sustain debt, with debt rising as ownership becomes more concentrated. These results are robust to adding foreign investors, redistributive taxes, or a second asset.