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Sovereign Default and Liquidity: The Case for a World Safe Asset

Author

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  • François Le Grand

    (EM - EMLyon Business School, ETH Zürich - Eidgenössische Technische Hochschule - Swiss Federal Institute of Technology [Zürich])

  • Xavier Ragot

    (ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique, CNRS - Centre National de la Recherche Scientifique, OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po)

Abstract

This paper presents a positive and normative study of a world financial market when sovereign countries can default on their debt. We construct a tractable model that enables us to study sovereign default in general equilibrium. The amount of safe assets is thus endogenous and determined by international risk-sharing. We characterize the equilibrium structure and we show that the market equilibrium can generate multiple equilibria. In addition, the market equilibrium is not constrained-efficient because countries do not fully internalize the value of their debt being used as liquidity. We prove that a world fund issuing a safe asset increases aggregate welfare. The fund's relationship with the IMF's Special Drawing Rights is discussed.

Suggested Citation

  • François Le Grand & Xavier Ragot, 2021. "Sovereign Default and Liquidity: The Case for a World Safe Asset," Post-Print hal-03501397, HAL.
    • Handle: RePEc:hal:journl:hal-03501397
    DOI: 10.1016/j.jinteco.2021.103462
    Note: View the original document on HAL open archive server: https://sciencespo.hal.science/hal-03501397
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    Cited by:

    1. Alperovych, Yan & Divakaruni, Anantha & Le Grand, François, 2022. "FinTech Lending under Austerity," SocArXiv atsk9, Center for Open Science.
    2. Divakaruni, Anantha & Alperovych, Yan & Le Grand, François, 2022. "FinTech Lending under Austerity," OSF Preprints m4tps, Center for Open Science.

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    More about this item

    Keywords

    Sovereign Default; Safe Asset; International Liquidity;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • O19 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - International Linkages to Development; Role of International Organizations

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