Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/296308 
Year of Publication: 
2023
Citation: 
[Journal:] Quantitative Economics [ISSN:] 1759-7331 [Volume:] 14 [Issue:] 1 [Year:] 2023 [Pages:] 277-308
Publisher: 
The Econometric Society, New Haven, CT
Abstract: 
Quantitative models of sovereign default predict that governments reduce borrowing during recessions to avoid debt crises. A prominent implication of this behavior is that the resulting interest rate spread volatility is counterfactually low. We propose that governments borrow into debt crises because of frictions in the adjustment of their expenditures. We develop a model of government good production, which uses public employment and intermediate consumption as inputs. The inputs have varying degrees of downward rigidity, which means that it is costly to reduce them. Facing an adverse income shock, the government borrows to smooth out the reduction in public employment, which results in increasing debt and higher spread. We quantify this rigidity using the OECD Government Accounts data and show that it explains about 70% of the missing bond spread volatility.
Subjects: 
Sovereign default
long-term debt
public goods
JEL: 
F34
G15
Persistent Identifier of the first edition: 
Creative Commons License: 
cc-by-nc Logo
Document Type: 
Article

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