Sovereign debt markets in turbulent times: creditor ... · Crowding-out effects arise because...

SOVEREIGN DEBT MARKETS IN TURBULENT TIMES:CREDITOR DISCRIMINATION AND CROWDING-OUT EFFECTS

Fernando Broner, Aitor Erce, Alberto Martin and Jaume Ventura

Documentos de Trabajo N.º 1402

2014

SOVEREIGN DEBT MARKETS IN TURBULENT TIMES:

CREDITOR DISCRIMINATION AND CROWDING-OUT EFFECTS

(*) We thank Tom Schmitz and Beatriz Urquizu for excellent research assistance. We received valuable comments from Klaus Adam, Cinzia Alcidi, Christoph Bertsch, Mark Wright and participants at presentations held at Banco Central de Chile, Banco de España, Barcelona GSE Summer Forum, Bocconi, Bruegel, Carnegie-Rochester-NYU conference, ECB, EUI, Harvard, IMF, Maryland, MIT, Princeton, Science Po, Toulouse and World Bank. We acknowledge financial support from the Spanish Ministry of Science and Innovation, the Spanish Ministry of Economy and Competitiveness Severo Ochoa Program, the Generalitat de Catalunya, and the European Research Council (Starting Grant FP7-263846 and Advanced Grant FP7-249588). The paper was partly written while Broner was visiting MIT. Previous versions of this paper were circulated under the title “Secondary Markets in Turbulent Times: Distortions, Disruptions and Bailouts.”(**) The views in this paper are the authors’ and do not reflect those of the European Stability Mechanism.

Documentos de Trabajo. N.º 1402

2014

Fernando Broner, Alberto Martin and Jaume Ventura

CREI, UNIVERSITAT POMPEU FABRA, AND BARCELONA GSE

Aitor Erce (**)

BANCO DE ESPAÑA AND EUROPEAN STABILITY MECHANISM

SOVEREIGN DEBT MARKETS IN TURBULENT TIMES: CREDITOR DISCRIMINATION

AND CROWDING-OUT EFFECTS (*)

The Working Paper Series seeks to disseminate original research in economics and fi nance. All papers have been anonymously refereed. By publishing these papers, the Banco de España aims to contribute to economic analysis and, in particular, to knowledge of the Spanish economy and its international environment.

The opinions and analyses in the Working Paper Series are the responsibility of the authors and, therefore, do not necessarily coincide with those of the Banco de España or the Eurosystem.

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Reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged.

© BANCO DE ESPAÑA, Madrid, 2014

ISSN: 1579-8666 (on line)

Abstract

In 2007, countries in the euro periphery were enjoying stable growth, low defi cits and low

spreads. Then the fi nancial crisis erupted and pushed them into deep recession, raising

their defi cits 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 fi nancial 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-fulfi lling 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 classifi cation: F32, F34, F36, F41, F43, F44, F65, G15.

Resumen

En 2007, los países de la periferia europea disfrutaban de un crecimiento estable, y défi cits

fi scales y primas de riesgo reducidos. Sin embargo, la crisis fi nanciera global empujó a estas

mismas economías a profundas recesiones, aumentando sus défi cits públicos y volúmenes

de deuda pública de tal forma que en 2010 estas economías comenzaron a sufrir episodios

de crisis de deuda soberana muy severos. Al tiempo que las primas de riesgo aumentaban,

también lo hizo la proporción de la deuda pública en manos de inversores residentes. De esta

forma, el crédito disponible fue reasignado del sector privado al sector público, lo que vino

acompañado de una caída en la inversión privada y un agravamiento de la recesión económica.

En este trabajo proponemos un modelo de riesgo soberano, en el que la deuda pública se

negocia en mercados secundarios, y que es capaz de racionalizar todos estos hechos

estilizados. El modelo tiene dos ingredientes principales: discriminación entre acreedores y

«efecto expulsión» (crowding-out effect, en inglés). La discriminación entre acreedores aparece

porque, durante periodos de turbulencias fi scales, la deuda pública ofrece un retorno esperado

más alto a inversores residentes que a inversores extranjeros, lo cual genera incentivos para

que los primeros compren, a través de los mercados secundarios, las tenencias de deuda de

los segundos. El «efecto expulsión» aparece porque la provisión de crédito al sector privado

está limitada por fricciones fi nancieras (restricciones de colateral). Esto implica que las compras

de deuda pública por parte de los inversores residentes desplaza (expulsa) la inversión

productiva. El modelo muestra que esas compras pueden reducir el crecimiento económico

y el bienestar agregado, y conducir a la economía a sufrir crisis autorrealizables (self-fulfi lling

crises, en inglés). El modelo también muestra como este «efecto expulsión» puede transmitirse

a otros miembros de la Unión Monetaria y como estas inefi ciencias pueden ser amortiguadas

mediante la aplicación de políticas a nivel europeo.

Palabras clave: deuda soberana, discriminación, efecto expulsión, crisis de refi nanciación,

crecimiento económico.

Códigos JEL: F32, F34, F36, F41, F43, F44, F65, G15.

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An increase in debt

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Increase in dt

A decrease in the probability of repayment

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Panel (a): zero default probability

kt

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Panel (b): small default probability

kt

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Panel (c): intermediate default probability

kt

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Panel (d): high default probability

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Panel (a): both steady states in the crisis zone

kt

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Panel (b): absorbing high steady state

kt

kt+1

Panel (c): absorbing low steady state

kt

kt+1

Panel (d): both steady states outside the crisis zone

kt

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k∗Hk∗H

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0 5 10 15 20 25 300

0.2

0.4

Time

CapitalStock

Panel (a): Low debt, low breakup probability

South

North

0 5 10 15 20 25 300

0.2

0.4

Time

CapitalStock

Panel (b): Low debt, high breakup probability

South

North

0 5 10 15 20 25 300

0.2

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CapitalStock

Panel (c): High debt, low breakup probability

South

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0 5 10 15 20 25 300

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Panel (d): High debt, high breakup probability

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d t = 6

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