self-fulfilling debt restructuring (job market paper)
Sovereign defaults are costly not only because countries lose access to financial markets, but also because of output lost during the delays and haircuts associated with debt restructuring. Debt restructuring outcomes vary widely, and longer delays and larger haircuts are associated with higher spreads post-restructuring. I build a model with this novel mechanism of self-fulfilling debt restructuring in mind: higher spreads due to investor pessimism make it harder for countries to recover, thereby prolonging the restructuring process and lowering the amount of debt eventually recovered (raising the haircut), qualitatively replicating the aforementioned empirical regularities. Quantitatively, the model matches evidence on post-default restructuring for Argentina well, without impeding its ability to match standard pre-default business cycle statistics. Generating variation in post-default restructuring outcomes endogenously through variation in the spread and other pre-default aggregates points to the significant challenge of simultaneously matching both sets of moments successfully. Due to the inefficiencies associated with the restructuring process, there is scope for economic policies that mitigate rollover risk that gives rise to prolonged, self-fulfilling debt restructuring. To this end, I show that by lowering debt service requirements, longer debt maturity not only helps to circumvent default, but also shortens the duration of costly debt restructuring and raises the amount of debt recovered,
highlighting a new channel by which maturity choice impacts efficiency and welfare.
Paper
highlighting a new channel by which maturity choice impacts efficiency and welfare.
Paper
debt sustainability and the terms of official support
with Giancarlo Corsetti and Aitor Erce
We study theoretically and quantitatively debt sustainability under two types of institutional bailouts: a long maturity-low spread package (typically offered by EFSF-ESM in Europe), and short maturity-high spread package (typically offered by the International
Monetary Fund). We show that, for lower levels of debt, the mere availability of official bailouts can induce private-sector bail-in of distressed governments thereby raising sustainability. For higher levels of debt, however, official disbursements become necessary, and can be counterproductive if improperly structured. While both significant, we find that longer maturities have a
stronger effect on sustainability than lower spreads. Quantitatively, our model is able to replicate Portuguese debt and spread dynamics in the recent crisis. In contrast with conventional wisdom and standard practice focusing on debt levels, we show that debt composition, long and short, private and public is critical for assessing sustainability. We find that any debt level between 50 and 180 percent of GDP can be sustained, depending on the maturity and spread of funds offered by official lending agencies.
Paper
We study theoretically and quantitatively debt sustainability under two types of institutional bailouts: a long maturity-low spread package (typically offered by EFSF-ESM in Europe), and short maturity-high spread package (typically offered by the International
Monetary Fund). We show that, for lower levels of debt, the mere availability of official bailouts can induce private-sector bail-in of distressed governments thereby raising sustainability. For higher levels of debt, however, official disbursements become necessary, and can be counterproductive if improperly structured. While both significant, we find that longer maturities have a
stronger effect on sustainability than lower spreads. Quantitatively, our model is able to replicate Portuguese debt and spread dynamics in the recent crisis. In contrast with conventional wisdom and standard practice focusing on debt levels, we show that debt composition, long and short, private and public is critical for assessing sustainability. We find that any debt level between 50 and 180 percent of GDP can be sustained, depending on the maturity and spread of funds offered by official lending agencies.
Paper
STRUCTURAL CHANGE IN AN OPEN ECONOMY
with Kei-Mu Yi and Jing Zhang
Journal of Monetary Economics, September 2013, 60 (6), 667-682.
We study the importance of international trade in structural change. Our framework has both productivity and trade cost shocks, and allows for non-unitary income and substitution elasticities. We calibrate our model to investigate South Korea’s structural change between 1971 and 2005. We find that the shock processes, propagated through the model’s two main transmission mechanisms, non-homothetic preferences and the open economy, explain virtually all of the evolution of agriculture and services labor shares, and the rising part of the hump-shape in manufacturing. Counterfactual exercises show that the role of the open economy is quantitatively important for explaining South Korea’s structural change.
Paper
Journal of Monetary Economics, September 2013, 60 (6), 667-682.
We study the importance of international trade in structural change. Our framework has both productivity and trade cost shocks, and allows for non-unitary income and substitution elasticities. We calibrate our model to investigate South Korea’s structural change between 1971 and 2005. We find that the shock processes, propagated through the model’s two main transmission mechanisms, non-homothetic preferences and the open economy, explain virtually all of the evolution of agriculture and services labor shares, and the rising part of the hump-shape in manufacturing. Counterfactual exercises show that the role of the open economy is quantitatively important for explaining South Korea’s structural change.
Paper
ZEROS AND THE GAINS FROM OPENNESS
Despite the enormous growth in global trade and investment, most countries still do not trade or invest with one other. I document that 80% of bilateral trade and FDI relationships are zeros. I construct a model that rationalizes these zeros and allows new bilateral relationships to form (aggregate zero-to-one transitions) following policy reform. Firms incur two types of costs when operating internationally: (1) fixed costs preventing them from operating - identified using variation in zeros, and (2) iceberg costs reducing the amount they sell when they operate – identified using variation in positive flows. The global bilateral fixed costs estimated from the zeros are novel to the literature, which has focused on country- or sector-specific fixed costs. To solve this model with severe non-convexities, I develop an algorithm that (1) computes an approximate equilibrium where exact equilibria do not exist, and (2) reduces computational complexity so it grows linearly, and not exponentially, in the number of countries, mitigating the curse of dimensionality. Welfare gains in models with no aggregate entry and exit account for only 41% of the average gains obtained in the model where zeros matter, signifying that this aggregate extensive margin matters for understanding what countries gain from openness.
Paper Technical Appendix
Paper Technical Appendix