Cancelled - Capital Flows, Default, and Renegotiation in a Small Open Economy

Tuesday 24 April 2018, 2.00PM to 3.00pm

Speaker(s): Udara Peiris, Associate Professor of Finance, International College of Economics and Finance, National Research University - Higher School of Economics, Moscow

Abstract

The post-2008 period focused attention on "twin-crises". Banking crises may lead to sovereign crises where fiscal vulnerabilities are exacerbated by the extension of support for the banking system. We develop a model that describes private sector generated capital inflow that is used to finance investment and consumption expenditure. In the event of an economic contraction, the (convex) haircut on outstanding debt is negotiated, or bargained, centrally by the sovereign. Two results arise: the volume of debt and haircut rate are inefficient. In this setting the accumulation of capital achieves two goals. First, it generates sufficient optimism about future income to allow the debt market to function. Second, and counter-intuitively, it increases expected haircuts by raising the value of the outside option of complete default. These competing forces characterize the optimal balanced-budget macroprudential policy targeting capital investment.


https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2910492

Location: HERC Seminar Room

Admission: All welcome