Sovereign Debt Markets in Turbulent Times: Creditor Discrimination and Crowding-Out Effects

69 Pages Posted: 15 Feb 2014

See all articles by Fernando Broner

Fernando Broner

CREI; Barcelona GSE; Universitat Pompeu Fabra; CEPR

Alberto Martin

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Centre for Economic Policy Research (CEPR)

Jaume Ventura

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI)

Aitor Erce

UPNA

Multiple version iconThere are 3 versions of this paper

Date Written: February 14, 2014

Abstract

In 2007, countries in the euro periphery were enjoying stable growth, low deficits and low spreads. Then the financial crisis erupted and pushed them into deep recession, raising their deficits and debt levels. By 2010, they were facing severe debt problems. Spreads increased and, surprisingly, so did the share of the debt held by domestic creditors. Credit was reallocated from the private to the public sector, reducing investment and deepening the recession even further. To account for these facts, we propose a simple model of sovereign risk in which debt can be traded in secondary markets. The model has two key ingredients: creditor discrimination and crowding-out effects. Creditor discrimination arises because, in turbulent times, sovereign debt offers a higher expected return to domestic creditors than to foreign ones. This provides incentives for domestic purchases of debt. Crowding-out effects arise because private borrowing is limited by financial frictions. This implies that domestic debt purchases displace productive investment. The model shows that these purchases reduce growth and welfare, and may lead to self-fulfilling crises. It also shows how crowding-out effects can be transmitted to other countries in the euro zone, and how they may be addressed by policies at the European level.

Keywords: sovereign debt, discrimination, crowding out, rollover crises, economic growth

JEL Classification: F32, F34, F36, F41, F43, F44, F65, G15

Suggested Citation

Broner, Fernando and Martin, Alberto and Ventura, Jaume and Erce, Aitor, Sovereign Debt Markets in Turbulent Times: Creditor Discrimination and Crowding-Out Effects (February 14, 2014). Banco de Espana Working Paper No. 1402, Available at SSRN: https://ssrn.com/abstract=2395761 or http://dx.doi.org/10.2139/ssrn.2395761

Fernando Broner (Contact Author)

CREI ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain
+34 93 542 2601 (Phone)

HOME PAGE: http://www.crei.cat/people/broner

Barcelona GSE

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
+34 93 542 2601 (Phone)

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain
+34 93 542 2601 (Phone)

HOME PAGE: http://www.crei.cat/people/broner

CEPR ( email )

London
United Kingdom
+34 93 542 2601 (Phone)

Alberto Martin

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Jaume Ventura

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

Aitor Erce

UPNA ( email )

Pamplona
Spain

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