Persistent gaps and default traps |
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Authors: | Luis AV Catão Ana Fostel Sandeep Kapur |
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Institution: | 1. Inter-American Development Bank, USA;2. International Monetary Fund, USA;3. George Washington University, Washington, DC, USA;4. Birkbeck, University of London, WC1E 7HX, UK |
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Abstract: | We show how vicious circles in countries' credit histories arise in a model where output persistence is coupled with asymmetric information about output shocks. In such an environment, default signals the borrower's vulnerability to adverse shocks and creates a pessimistic growth outlook. This translates into higher interest spreads and debt servicing costs relative to income, raising the cost of future repayments, thereby creating “default traps”. We build a long and broad cross-country dataset to show the existence of a history-dependent “default premium” and of significant effects of output persistence on sovereign creditworthiness, consistent with the model's predictions. |
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Keywords: | F34 G15 H63 N20 |
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