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Default risk, sectoral reallocation, and persistent recessions

Author: Cristina Arellano; Yan Bai; Gabriel Mihalache; National Bureau of Economic Research,
Publisher: Cambridge, Mass. : National Bureau of Economic Research, 2017.
Series: Working paper series (National Bureau of Economic Research), no. 23835.
Edition/Format:   eBook : Document : EnglishView all editions and formats
Summary:
Sovereign debt crises are associated with large and persistent declines in economic activity, disproportionately so for nontradable sectors. This paper documents this pattern using Spanish data and builds a two-sector dynamic quantitative model of sovereign default with capital accumulation. Recessions are very persistent in the model and more pronounced for nontraded sectors because of default risk. An adverse  Read more...
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Material Type: Document, Internet resource
Document Type: Internet Resource, Computer File
All Authors / Contributors: Cristina Arellano; Yan Bai; Gabriel Mihalache; National Bureau of Economic Research,
OCLC Number: 1004309505
Notes: "September 2017"
Description: 1 online resource (36 pages) : illustrations.
Series Title: Working paper series (National Bureau of Economic Research), no. 23835.
Responsibility: Cristina Arellano, Yan Bai, Gabriel Mihalache.

Abstract:

Sovereign debt crises are associated with large and persistent declines in economic activity, disproportionately so for nontradable sectors. This paper documents this pattern using Spanish data and builds a two-sector dynamic quantitative model of sovereign default with capital accumulation. Recessions are very persistent in the model and more pronounced for nontraded sectors because of default risk. An adverse domestic shock increases the likelihood of default, limits capital inflows, and thus restricts the ability of the economy to exploit investment opportunities. The economy responds by reducing investment and reallocating capital toward the traded sector to support debt service payments. The real exchange rate depreciates, a reflection of the scarcity of traded goods. We find that these mechanisms are quantitatively important for rationalizing the experience of Spain during the recent debt crisis.

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