Faculty of Economics and Business Administration Publications Database

Sovereign and private default risks over the business cycle

Mellert, Jan
Scholl, Almuth
ISSN-Print: 0022-1996
Year: 2020
Keywords: Sovereign default; Corporate borrowing; Interest rate spreads; Fiscal policy

Sovereign debt crises are often accompanied by deep recessions with sharp declines in external credit to the private sector. In a sample of emerging economies we find that both, sovereign and private interest rate spreads are countercyclical. This paper presents a model of a small open economy that accounts for these empirical regularities. It includes private firms, which finance a fraction of imports by external debt and are subject to idiosyncratic productivity risk, and a government, which borrows internationally and taxes firms to finance public expenditures. The model gives rise to endogenous private and sovereign interest rate spreads and a dynamic feedback mechanism between sovereign and private default risks through the endogenous response of fiscal policy to adverse productivity shocks.