Staff Report 589

Partial Default

Cristina Arellano | Assistant Director and Monetary Advisor
Xavier Mateos-Planas | Queen Mary University of London, Centre for Macroeconomics
José-Víctor Ríos-Rull | University of Pennsylvania, UCL, CAERP, CEPR and NBER

Published July 9, 2019

Abstract
In the data sovereign default is always partial and varies in its duration. Debt levels during default episodes initially increase and do not experience reductions upon resolution. This paper presents a theory of sovereign default that replicates these properties, which are absent in standard sovereign default theory. Partial default is a flexible way to raise funds as the sovereign chooses its intensity and duration. Partial default is also costly because it amplifies debt crises as the defaulted debt accumulates and interest rate spreads increase. This theory is capable of rationalizing the large heterogeneity in partial default, its comovements with spreads, debt levels, and output, and the dynamics of debt during default episodes. In our theory, as in the data, debt grows during default episodes, and large defaults are longer, and associated with higher interest rate spreads, higher debt levels, and deeper recessions.

DOI: https://doi.org/10.21034/sr.589


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