This website uses cookies.

By clicking the "Accept" button or continuing to browse our site, you agree to first-party and session-only cookies being stored on your device to enhance site navigation and analyze site performance and traffic. For more information on our use of cookies, please see our Privacy Policy.

  1. Home
  2. Journals
  3. American Economic Review
  4. Forthcoming Articles
  5. Default and Interest Rate Shocks: Renegotiation Matters

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Default and Interest Rate Shocks: Renegotiation Matters

  • Juan Nicolini
  • Victor Almeida
  • Carlos Esquivel
  • Timothy J. Kehoe
American Economic Review (Forthcoming)

Abstract

We develop a sovereign default model with debt renegotiation in which interest-rate shocks affect default incentives through two mechanisms. Under the standard mechanism, higher interest rates tighten the government’s budget constraint. Under the renegotiation mechanism, higher rates increase lenders’ opportunity cost of holding delinquent debt, which makes lenders accept larger haircuts and makes default more attractive for the government. We argue that our novel renegotiation mechanism reconciles standard sovereign default models with the narrative that the sharp increase in the real interest rate in the United States was a relevant factor in the defaults of the early 1980s.

Downloads