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Honoring sovereign debt or bailing out domestic residents? The limits to bailouts

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  • Mengus, Eric

Abstract

Why does a borrowing country not avoid the internal cost of default, an important driver of sovereign debt repayment, by implementing domestic sector bailouts? This paper investigates sovereign debt sustainability in a model where domestic and foreign investors optimally select their portfolios and the sovereign decides over its default and bailout policies. It shows that internal bailouts do not preclude sovereign borrowing when domestic private exposures to sovereign debt, direct or indirect, cannot be observed or inferred by the sovereign. In equilibrium, when these exposures are correlated with future liquidity needs, bailouts are less efficient to compensate domestic losses making repayment more desirable. “Opacity" on financial exposures is then a commitment device for sovereigns to honor their debts and thus may be welfare improving.

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  • Mengus, Eric, 2018. "Honoring sovereign debt or bailing out domestic residents? The limits to bailouts," Journal of International Economics, Elsevier, vol. 114(C), pages 14-24.
    • Handle: RePEc:eee:inecon:v:114:y:2018:i:c:p:14-24
    DOI: 10.1016/j.jinteco.2018.05.001
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    Cited by:

    1. D’Erasmo, Pablo & Mendoza, Enrique G., 2021. "History remembered: Optimal sovereign default on domestic and external debt," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 969-989.
    2. Broner, Fernando & Erce, Aitor & Martin, Alberto & Ventura, Jaume, 2014. "Sovereign debt markets in turbulent times: Creditor discrimination and crowding-out effects," Journal of Monetary Economics, Elsevier, vol. 61(C), pages 114-142.
    3. Gennaioli, Nicola & Martin, Alberto & Rossi, Stefano, 2018. "Banks, government Bonds, and Default: What do the data Say?," Journal of Monetary Economics, Elsevier, vol. 98(C), pages 98-113.
    4. Mengus, Eric, 2023. "Asset purchase bailouts and endogenous implicit guarantees," Journal of International Economics, Elsevier, vol. 142(C).
    5. Fernando Broner & Aitor Erce & Alberto Martin & Jaume Ventura, 2013. "Sovereign Debt Markets in Turbulent Times: Creditor Discrimination and Crowding-Out," IMF Working Papers 2013/270, International Monetary Fund.
    6. Ernesto Pasten, 2020. "Prudential Policies and Bailouts: A Delicate Interaction," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 38, pages 181-197, October.
    7. Eric Mengus, 2012. "Foreign Debt and the Ricardian Equivalence," 2012 Meeting Papers 412, Society for Economic Dynamics.

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    More about this item

    Keywords

    Sovereign debt; Internal cost of default; Bailouts;
    All these keywords.

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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