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Optimal Sovereign Default †

Optimal Sovereign Default † Abstract When is it optimal for a fully committed government to default on its legal repayment obligations? Considering a small open economy with domestic production risk and noncontingent government debt, we show that it is ex ante optimal to occasionally deviate from the legal repayment obligation and to repay debt only partially. This holds true even if default generates significant deadweight costs ex post. A quantitative analysis reveals that default is optimal only in response to persistent disaster-like shocks to domestic output. Applying the framework to the situation in Greece, we find that optimal default policies suggest a considerably larger and more timely default than the one actually implemented in the year 2012. (JEL E23, E62, F41, H63 ) http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png American Economic Journal: Macroeconomics American Economic Association

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Publisher
American Economic Association
Copyright
Copyright © 2017 by the American Economic Association
Subject
Articles
ISSN
1945-7715
eISSN
1945-7715
DOI
10.1257/mac.20140093
Publisher site
See Article on Publisher Site

Abstract

Abstract When is it optimal for a fully committed government to default on its legal repayment obligations? Considering a small open economy with domestic production risk and noncontingent government debt, we show that it is ex ante optimal to occasionally deviate from the legal repayment obligation and to repay debt only partially. This holds true even if default generates significant deadweight costs ex post. A quantitative analysis reveals that default is optimal only in response to persistent disaster-like shocks to domestic output. Applying the framework to the situation in Greece, we find that optimal default policies suggest a considerably larger and more timely default than the one actually implemented in the year 2012. (JEL E23, E62, F41, H63 )

Journal

American Economic Journal: MacroeconomicsAmerican Economic Association

Published: Jan 1, 2017

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