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Essays in Macroeconomics and Sovereign Default

Galli, Carlo; (2020) Essays in Macroeconomics and Sovereign Default. Doctoral thesis (Ph.D), UCL (University College London). Green open access

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Abstract

This thesis studies government fiscal, monetary and debt policy, with a particular focus on debt crises and the pricing of default risk. The first chapter studies the circular relationship between sovereign credit risk, government fiscal and debt policy, and output. I show that, when fiscal policy responds to borrowing conditions in the sovereign debt market, multiple equilibria exist where the expectations of lenders are self-fulfilling. This result is reminiscent of the European debt crisis of 2010-12: while recessionary, fiscal austerity may be the government best response to excessive borrowing costs during a confidence crisis. The second chapter studies the information sensitivity of government debt denominated in domestic vs. foreign currency: the former is subject to inflation risk and the latter to default. Default only affects sophisticated bond traders, whereas inflation concerns a larger and less informed group. Within a two-period Bayesian trading game, we display conditions under which debt prices are more resilient to bad news. Our results can explain debt prices across countries following the 2008 financial crisis, and also provide a theory of ``original sin." The third chapter explores the trade-off between strategic inflation and default for a set of large emerging market economies that borrow mostly in their local currency. Using derivatives data, I find a robust, positive correlation between default risk, expected and realised inflation. I use these facts to discipline a quantitative sovereign default model where a government issues debt in domestic currency and lacks commitment to fiscal and monetary policy. I show that simple models of debt dilution via default and inflation have counterfactual implications. I highlight the role of monetary financing in matching the data, allowing inflation to serve a second purpose: in bad times, seigniorage is especially useful as a flexible source of funding when other margins are hard to adjust.

Type: Thesis (Doctoral)
Qualification: Ph.D
Title: Essays in Macroeconomics and Sovereign Default
Event: UCL
Open access status: An open access version is available from UCL Discovery
Language: English
Additional information: Copyright © The Author 2020. Original content in this thesis is licensed under the terms of the Creative Commons Attribution 4.0 International (CC BY 4.0) Licence (https://creativecommons.org/licenses/by/4.0/). Any third-party copyright material present remains the property of its respective owner(s) and is licensed under its existing terms. Access may initially be restricted at the author’s request.
UCL classification: UCL
UCL > Provost and Vice Provost Offices
UCL > Provost and Vice Provost Offices > UCL SLASH
UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of S&HS
UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of S&HS > Dept of Economics
URI: https://discovery.ucl.ac.uk/id/eprint/10113069
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