We establish that creditor beliefs regarding future borrowing can be self-fulfilling, leading to multiple equilibria with markedly different debt accumulation patterns. We characterize such indeterminacy in the Eaton-Gersovitz sovereign debt model augmented with long maturity bonds. Two necessary conditions for the multiplicity are: (i) the government is more impatient than foreign creditors, and (ii) there are deadweight losses from default; both are realistic and standard assumptions in the quantitative literature. The multiplicity is dynamic and stems from the self-fulfilling beliefs of how future creditors will price bonds; long maturity bonds are therefore a crucial component of the multiplicity. We introduce a third party with deep pockets to discuss the policy implications of this source of multiplicity and identify the potentially perverse consequences of traditional "lender of last resort" policies.
Since 2004, time-use data show that younger men, ages 21 to 30, shifted their leisure sharply to video gaming and other recreational computer activities. Over the same period, these younger men exhibited a larger decline in work hours than older men or women. We propose a framework to answer whether improved leisure technology affected younger men's labor supply. The starting point is a leisure demand system that parallels that often estimated for consumer expenditures. We show that total leisure demand is especially sensitive to innovations in leisure luxuries, that is, activities that display a disproportionate response to changes in total leisure time. Using cross-region variation, we estimate that gaming/recreational computer use is distinctly a leisure luxury for younger men. We calculate that innovations to gaming/recreational computing reduced younger men's labor supply by 1.5 to 3.1 percent since 2004. That would explain 23 to 46 percent of their decline in market hours over the period.
We revisit self-fulfilling rollover crises by introducing an alternative equilibrium selection that involves bond auctions at depressed but strictly positive equilibrium prices, a scenario in line with observed sovereign debt crises. We refer to these auctions as ``desperate deals,'' the defining feature of which is a price schedule that makes the government indifferent to default or repayment. The government randomizes at the time of repayment, which we show can be implemented in pure strategies by introducing stochastic political payoffs or external bailouts. Quantitatively, auctions at fire-sale prices are crucial for generating realistic spread volatility.
We study the interactions between sovereign debt default and maturity choice in a setting with limited commitment for repayment as well as future debt issuances. Our main finding is that under a wide range of conditions the sovereign should, as long as default is not preferable, remain passive in long-term bond markets, making payments and retiring long-term bonds as they mature but never actively issuing or buying back such bonds. The only active debt-management margin is the short-term bond market. We show that any attempt to manipulate the existing maturity profile of outstanding long-term bonds generates losses, as bond prices move against the sovereign. Our results hold regardless of the shape of the yield curve. The yield curve captures the average costs of financing at different maturities but is misleading regarding the marginal costs.
In this chapter we explore the macroeconomics of time allocation. We begin with an overview of the trends in market hours in the US, both in the aggregate and for key sub-samples. After introducing a Beckerian theoretical framework, the chapter then discusses key empirical patterns of time allocation, both in the time series (including business cycle properties) and over the lifecycle. We focus on several core non-market activities, including home production, childcare, and leisure. The chapter concludes with a discussion of why these patterns are important to macroeconomics and spells out directions for future research.
This chapter is on quantitative models of sovereign debt crises in emerging economies. We interpret debt crises broadly to cover all of the major problems a country can experience while trying to issue new debt, including default, sharp increases in the spread and failed auctions. We examine the spreads on sovereign debt of 20 emerging market economies since 1993 and document the extent to which fluctuations in spreads are driven by country-specific fundamentals, common latent factors and observed global factors. Our findings motivate quantitative models of debt and default with the following features: (i) trend stationary or stochastic growth, (ii) risk averse competitive lenders, (iii) a strategic repayment/borrowing decision, (iv) multi-period debt, (v) a default penalty that includes both a reputation loss and a physical output loss and (vi) rollover defaults. For the quantitative evaluation of the model, we focus on Mexico and carefully discuss the successes and weaknesses of various versions of the model. We close with some thoughts on useful directions for future research.
We study optimal fiscal policy in a small open economy (SOE) with sovereign and private default risk and limited commitment to tax plans. The SOE's government uses linear taxation to fund exogenous expenditures and uses public debt to inter-temporally allocate tax distortions. We characterize a class of environments in which the tax on labor goes to zero in the long run, while the tax on capital income may be non-zero, reversing the standard prediction of the Ramsey tax literature. The zero labor tax is an optimal long run outcome if the economy is subject to sovereign debt constraints and the domestic households are impatient relative to the international interest rate. The front loading of tax distortions allows the economy to build a large (aggregate) debt position in the presence of limited commitment. We show that a similar result holds in a closed economy with imperfect inter-generational altruism, providing a link with the closed-economy literature that has explored disagreement between the government and its citizens regarding inter-temporal tradeoffs.
We characterize fiscal and monetary policy in a monetary union with the potential for rollover crises in sovereign debt markets. Member-country fiscal authorities lack commitment to repay their debt and choose fiscal policy independently. A common monetary authority chooses inflation for the union, also without commitment. We first describe the existence of a fiscal externality that arises in the presence of limited commitment and leads countries to over borrow; this externality rationalizes the imposition of debt ceilings in a monetary union. We then investigate the impact of the composition of debt in a monetary union, that is the fraction of high-debt versus low-debt members, on the occurrence of self-fulfilling debt crises. We demonstrate that a high-debt country may be less vulnerable to crises and have higher welfare when it belongs to a union with an intermediate mix of high- and low-debt members, than one where all other members are low-debt. This contrasts with the conventional wisdom that all countries should prefer a union with low-debt members, as such a union can credibly deliver low inflation. These findings shed new light on the criteria for an optimal currency area in the presence of rollover crises.
We revisit to what extent the increase in income inequality over the last 30 years has been mirrored by consumption inequality. We do so by constructing an alternative measure of consumption expenditure, using data from the Consumer Expenditure Survey (CE), that employs a demand system to correct for systematic measurement error. Specifically, we consider trends in the relative expenditure of high-income and low-income households for different goods with different expenditure elasticities. Our estimation exploits the difference in the growth rate of luxury consumption inequality versus necessity consumption inequality. This ``double-differencing,'' which we implement in a regression framework, corrects for mis-measurement that can systematically vary over time by good and income group. Our results show that consumption inequality has tracked income inequality much more closely than estimated by direct responses on expenditures.
Aguiar, Mark, and Manuel Amador. “Sovereign Debt”. Handbook of International Economics Vol 4. Elsevier, 2014. Print.Abstract
In this chapter, we use a benchmark limited-commitment model to explore key issues in the economics of sovereign debt. After highlighting conceptual issues that distinguish sovereign debt as well as reviewing a number of empirical facts, we use the model to discuss debt overhang, risk sharing, and capital flows in an environment of limited enforcement. We also discuss recent progress on default and renegotiation; self-fulfilling debt crises; and incomplete markets and their quantitative implications. We conclude with a brief assessment of the current state of the literature and highlight some directions for future research.
We propose a continuous time model of nominal debt and investigate the role of inflation credibility in the potential for self-fulfilling debt crises. Inflation is costly, but reduces the real value of outstanding debt without the full punishment of default. With high inflation credibility, which can be interpreted as joining a monetary union or issuing foreign currency debt, debt is effectively real. By contrast, with low inflation credibility, sovereign debt is nominal and in a debt crisis a government may opt to inflate away a fraction of the debt burden rather than explicitly default. This flexibility potentially reduces the country's exposure to self-fulfilling crises. On the other hand, the government lacks credibility not to inflate in the absence of crisis. This latter channel raises the cost of debt in tranquil periods and makes default more attractive in the event of a crisis, increasing the country's vulnerability. We characterize the interaction of these two forces. We show that there is an intermediate inflation credibility that minimizes the country's exposure to rollover risk. Low inflation credibility brings the worst of both worlds---high inflation in tranquil periods and increased vulnerability to a crisis.
In this paper we revisit two well-known facts regarding lifecycle expenditures. The first is the familiar ``hump'' shaped lifecycle profile of nondurable expenditures. The second is that cross-household consumption inequality increases steadily throughout the lifecycle. We document that the behavior of total nondurables masks surprising heterogeneity in the lifecycle profile of individual consumption sub-components. We provide evidence that the categories driving lifecycle consumption are either inputs into market work (clothing and transportation) or are amenable to home production (food). Using a quantitative model, we document that the disaggregated lifecycle consumption profiles imply a level of uninsurable permanent income risk that is similar to that implied by wage data and substantially lower than that implied by a model using only a composite consumption good.
Using data from the American Time Use Survey between 2003 and 2010, we document that home production absorbs roughly 30 percent of foregone market work hours at business cycle frequencies. Leisure absorbs roughly 50 percent of foregone market work hours, with sleeping and television watching accounting for most of this increase. We document significant increases in time spent on shopping, child care, education, and health. Job search absorbs between 2 and 6 percent of foregone market work hours. We discuss the implications of our results for business cycle models with home production and non-separable preferences.
We propose a tractable variant of the open economy neoclassical growth model that emphasizes political economy and contracting frictions. The political economy frictions involve a preference for immediate spending, while the contracting friction is a lack of commitment regarding foreign debt and expropriation. We show that the political economy frictions slow an economy's convergence to the steady state due to the endogenous evolution of capital taxation. The model rationalizes why openness has different implications for growth depending on the political environment, why institutions such as the treatment of capital income evolve over time, why governments in countries that grow rapidly accumulate net foreign assets rather than liabilities, and why foreign aid may not affect growth.
We characterize optimal taxation of foreign capital and optimal sovereign debt policy in a small open economy where the government cannot commit to policy, seeks to insure a risk averse domestic constituency, and is more impatient than the market. Optimal policy generates long-run cycles in both sovereign debt and foreign direct investment in an environment in which the first best capital stock is a constant. The expected tax on capital endogenously varies with the state of the economy and investment is distorted by more in recessions than in booms, amplifying the effect of shocks. The government's lack of commitment induces a negative correlation between investment and the stock of government debt, a ``debt overhang'' effect. Debt relief is never Pareto improving and cannot affect the long-run level of investment. Furthermore, restricting the government to a balanced budget can eliminate the cyclical distortion of investment.