Sovereign Defaults: Macroeconomic Activity and Political and Financial Frictions

Assistant Professor, University of Nebraska at Omaha.

Please see Prof. Feng's CV for more information.

This paper studies the impact of political and financial frictions on the macroeconomic activity around sovereign defaults. We compile a data-set that contains 16 default episodes. We examine the behavior of the economy around the time when default happened, and document a set of stylized facts. To account for these empirical regularities, we introduce capital accumulation, endogenous government spending and taxation into an otherwise standard quantitative sovereign default model. We develop a novel numerical method to solve the equilibrium. The baseline economy is calibrated to match the macroeconomic dynamics of the average economy in our data-set. We use this model to explore how various political friction (government spending and / or taxation rigidity, etc.) and financial frictions (capital quality loss, etc.) affect the government's decision whether to default on their debt obligation or not, and the feedback effects of their fiscal policy on macroeconomic activities.