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Code and data files for "Fiscal Policy and Default Risk in Emerging Markets"
TL;DR: In this article, all Matlab and C++ programs necessary to produce the results of the article were described and a spreadsheet with Mexican data was also provided, along with a spreadsheet containing Mexican data.
Abstract: All Matlab and C++ programs necessary to produce the results of the article. There is also a Excel spreadsheet with Mexican data.
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TL;DR: In this paper, a general equilibrium model of both sovereign default and business cycles is proposed, which explains several features of cyclical dynamics around deraults, countercyclical spreads, high debt ratios and key business cycle moments.
Abstract: Emerging markets business cycle models treat default risk as part of an exogenous interest rate on working capital, while sovereign default models treat income fluctuations as an exogenous endowment process with ad-noc default costs. We propose instead a general equilibrium model of both sovereign default and business cycles. In the model, some imported inputs require working capital financing; default on public and private obligations occurs simultaneously. The model explains several features of cyclical dynamics around default triggers an efficiency loss as these inputs are replaced by imperfect substitutes; and default on public and private obligations occurs simultaneously. The model explains several features of cyclical dynamics around deraults, countercyclical spreads, high debt ratios, and key business cycle moments. This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.
464 citations
TL;DR: In this article, the authors build a dataset on tax rates for 62 countries for the period 1960-2013 that comprises corporate income, personal income, and value-added tax rates and find that tax policy is a cyclical in industrial countries but mostly procyclical in developing countries.
Abstract: It is well known by now that government spending has typically been procyclical in developing economies but a cyclical or countercyclical in industrial countries. Little, if any, is known, however, about the cyclical behavior of tax rates (as opposed to tax revenues, which are endogenous to the business cycle and hence cannot shed light on the cyclicality of tax policy). The authors build a novel dataset on tax rates for 62 countries for the period 1960-2013 that comprises corporate income, personal income, and value-added tax rates. The authors find that, by and large, tax policy is a cyclical in industrial countries but mostly procyclical in developing countries. Further, tax policy in countries with better institutions and or more integrated with world capital markets tends to be less procyclical or more countercyclical.
142 citations
TL;DR: In this article, the authors extend the model used in recent quantitative studies of sovereign default, allowing policymakers of different types to stochastically alternate in power, and show that a default episode may be triggered by a change in the type of policymaker in office, and that such a default is likely to occur only if there is enough political stability and if policymakers encounter poor economic conditions.
Abstract: We extend the model used in recent quantitative studies of sovereign default, allowing policymakers of different types to stochastically alternate in power. We show that a default episode may be triggered by a change in the type of policymaker in office, and that such a default is likely to occur only if there is enough political stability and if policymakers encounter poor economic conditions. Under high political stability, political turnover enables the model to generate a weaker correlation between economic conditions and default decisions, a higher and more volatile spread, and lower borrowing levels after a default episode.
132 citations
TL;DR: In this article, the authors identify critical flaws in the traditional approach to evaluate debt sustainability, and examine three alternative approaches that provide useful econometric and model-simulation tools to analyze debt sustainability.
Abstract: The question of what is a sustainable public debt is paramount in the macroeconomic analysis of fiscal policy. This question is usually formulated as asking whether the outstanding public debt and its projected path are consistent with those of the government's revenues and expenditures (ie, whether fiscal solvency conditions hold). We identify critical flaws in the traditional approach to evaluate debt sustainability, and examine three alternative approaches that provide useful econometric and model-simulation tools to analyze debt sustainability. The first approach is Bohn's nonstructural empirical framework based on a fiscal reaction function that characterizes the dynamics of sustainable debt and primary balances. The second is a structural approach based on a calibrated dynamic general equilibrium framework with a fully specified fiscal sector, which we use to quantify the positive and normative effects of fiscal policies aimed at restoring fiscal solvency in response to changes in debt. The third approach deviates from the others in assuming that governments cannot commit to repay their domestic debt and can thus optimally decide to default even if debt is sustainable in terms of fiscal solvency. We use these three approaches to analyze debt sustainability in the United States and Europe after the sharp increases in public debt following the 2008 crisis, and find that all three raise serious questions about the prospects of fiscal adjustment and its consequences.
110 citations
TL;DR: In this paper, the authors study the sovereign default model that has been used to account for the cyclical behavior of interest rates in emerging market economies and show that this method necessitates a large number of grid points to avoid generating spurious interestrate movements.
Abstract: We study the sovereign default model that has been used to account for the cyclical behavior of interest rates in emerging market economies. This model is often solved using the discrete state space technique with evenly spaced grid points. We show that this method necessitates a large number of grid points to avoid generating spurious interestrate movements. This makes the discrete state technique significantly more inefficient than using Chebyshev polynomials or cubic spline interpolation to approximate the value functions. We show that the inefficiency of the discrete state space technique is more severe for parameterizations that feature a high sensitivity of the bond price to the borrowing level for the borrowing levels that are observed more frequently in the simulations. In addition, we find that the efficiency of the discrete state space technique can be greatly improved by (i) finding the equilibrium as the limit of the equilibrium of the finite-horizon version of the model, instead of iterating separately on the value and bond price functions and (ii) concentrating grid points in asset levels at which the bond price is more sensitive to the borrowing level and in levels that are observed more often in the model simulations. Our analysis is also relevant for the study of other credit markets.
105 citations
References
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TL;DR: This paper developed a small open economy model to study default risk and its interaction with output, consumption, and foreign debt, which predicts that default incentives and interest rates are higher in recessions, as observed in the data.
Abstract: Recent sovereign defaults in emerging countries are accompanied by interest rate spikes and deep recessions. This paper develops a small open economy model to study default risk and its interaction with output, consumption, and foreign debt. Default probabilities and interest rates depend on incentives for repayment. Default occurs in equilibrium because asset markets are incomplete. The model predicts that default incentives and interest rates are higher in recessions, as observed in the data. The reason is that in a recession, a risk averse borrower finds it more costly to repay non-contingent debt and is more likely to default. In a quantitative exercise the model matches various features of the business cycle in Argentina such as: high volatility of interest rates, higher volatility of consumption relative to output, a negative correlation of interest rates and output and a negative correlation of the trade balance and output. The model can also predict the recent default episode in Argentina.
938 citations
TL;DR: In this paper, the authors used a new, comprehensive database on fiscal outcomes in 13 major Latin American economies which covers central government, local government, and non-financial public enterprises at a reasonably detailed level of aggregation.
Abstract: Fiscal policy in Latin America has been understudied, in part because of inadequate data. This paper utilizes a new, comprehensive database on fiscal outcomes in 13 major Latin American economies which covers central government, local government, and nonfinancial public enterprises at a reasonably detailed level of aggregation. Armed with this database, we lay out some basic facts about fiscal policy in Latin America. We find stark differences between fiscal outcomes in Latin America and in industrial countries. Fiscal outcomes have been far more volatile in Latin America. In sharp contrast to the industrial economies, fiscal policy in Latin America has also been procyclical, casting doubt on the applicability of the Barro (1979) tax-smoothing hypothesis to Latin America. We discuss alternative explanations of fiscal policy procyclicality. We also consider the relationship of fiscal policy to the exchange-rate regime. Contrary to much conventional wisdom, we find no evidence that fixed exchange rates impo...
804 citations
"Code and data files for "Fiscal Pol..." refers background in this paper
...Gavin and Perotti (1997) (from now on GP) document that fiscal policy is procyclical in Latin America....
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TL;DR: This article developed a quantitative model of debt and default in a small open economy and used this model to match four empirical regularities regarding emerging markets: defaults occur in equilibrium, interest rates are countercyclical, net exports are counter cyclical, and interest rates and the current account are positively correlated.
Abstract: World capital markets have experienced large scale sovereign defaults on a number of occasions, the most recent being Argentina's default in 2002. In this paper we develop a quantitative model of debt and default in a small open economy. We use this model to match four empirical regularities regarding emerging markets: defaults occur in equilibrium, interest rates are countercyclical, net exports are countercyclical, and interest rates and the current account are positively correlated. That is, emerging markets on average borrow more in good times and at lower interest rates as compared to slumps. Our ability to match these facts within the framework of an otherwise standard business cycle model with endogenous default relies on the importance of a stochastic trend in emerging markets.
543 citations
"Code and data files for "Fiscal Pol..." refers background in this paper
...The parameter σ, the coefficient of relative risk aversion, is set equal to 2, a standard value (see Aguiar and Gopinath 2006)....
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...…and the more recent quantitative analysis on unsecured consumer default by Chatterjee et al. (2007), quantitative models on sovereign default by Aguiar and Gopinath (2006), Arellano (2008), Cuadra and Sapriza (2008), Hatchondo, Martinez and Sapriza (2008), Lizarazo (2006) and Yue (2007) among…...
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...32 Notice that income e y(y, d,D) depends on the output realization y and the indicator function that shows whether the private (d) and public (D) sectors defaulted (1) or not (0)....
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...The productivity shock is assumed to follow an AR(1) process...
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TL;DR: In this paper, the authors review the evidence on the importance of finance for economic well-being, provide data on the degree of usage of basic financial services by households and firms across a sample of countries, assesses the desirability of more universal access, and overviews the macroeconomic, legal and regulatory obstacles to access using general evidence and case studies.
Abstract: This paper reviews the evidence on the importance of finance for economic well-being, provides data on the degree of usage of basic financial services by households and firms across a sample of countries, assesses the desirability of more universal access, and overviews the macro-economic, legal and regulatory obstacles to access using general evidence and case studies. Although access to finance can be very beneficial, the data show that universal usage is far from prevalent in many countries, especially developing countries. At the same time, universal access has generally not been a public policy objective and is surely not easily achievable in most countries. Countries can, however, undertake many actions to facilitate access to financial services, including through strengthening their institutional infrastructures, liberalizing and opening up their markets and facilitating greater competition, and encouraging innovative use of know -how and technology. Government attempts and interventions to directly broaden the provision of access to finance, however, are fraught with risks and costs, among others, the risk of missing the targeted groups. The paper concludes with possible global actions aimed at improving data on access and usage and areas of further analysis to help identify the constraints to broadening access.
498 citations
TL;DR: In this paper, a general equilibrium model of both sovereign default and business cycles is proposed, which explains several features of cyclical dynamics around deraults, countercyclical spreads, high debt ratios and key business cycle moments.
Abstract: Emerging markets business cycle models treat default risk as part of an exogenous interest rate on working capital, while sovereign default models treat income fluctuations as an exogenous endowment process with ad-noc default costs. We propose instead a general equilibrium model of both sovereign default and business cycles. In the model, some imported inputs require working capital financing; default on public and private obligations occurs simultaneously. The model explains several features of cyclical dynamics around default triggers an efficiency loss as these inputs are replaced by imperfect substitutes; and default on public and private obligations occurs simultaneously. The model explains several features of cyclical dynamics around deraults, countercyclical spreads, high debt ratios, and key business cycle moments. This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.
464 citations