Hostname: page-component-586b7cd67f-t7czq Total loading time: 0 Render date: 2024-11-22T21:52:50.416Z Has data issue: false hasContentIssue false
  • English
  • Français

SOVEREIGN DEFAULT, TRADE, AND TERMS OF TRADE

Published online by Cambridge University Press:  02 September 2019

Grace Weishi Gu
Grace Weishi Gu*
Affiliation:
UC Santa Cruz
*
Address correspondence to: Grace Weishi Gu, Department of Economics, UC Santa Cruz, Engineering 2 Building, Room 463, Santa Cruz, CA 95060, USA. e-mail: [email protected].
Get access Rights & Permissions [Opens in a new window]

Abstract

Sovereign defaults are associated with income and trade reductions and terms-of-trade deterioration. This paper develops a two-country model to study the interactions between income, trade, terms of trade, and foreign-debt default risk and default events. Such default risk and events are costly because they adversely affect the demand for a borrower country’s intermediate goods exports and its income. Consequently, trade flows change due to the income loss and consumption home bias. The defaulter’s terms of trade also deteriorate endogenously, which accelerates its income and trade losses. The model produces procyclical imports, exports, terms of trade, and other empirical features of emerging countries’ business cycles and default episodes.

Keywords

Sovereign DefaultTerms of TradeTrade FlowsVertical Export
Type
Articles
Information
Macroeconomic Dynamics , Volume 25 , Issue 6 , September 2021 , pp. 1346 - 1380
Copyright
© Cambridge University Press 2019

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

I thank George Alessandria, Laura Alfaro, Yan Bai, Paul Bergin, George Bulman, Michael Dooley, Fabio Ghironi, Michael Hutchinson, Ken Kasa, Ken Kletzer, Huiyu Li, Leonardo Martinez, Eswar Prasad, Vincenzo Quadrini, Katheryn Russ, Ina Simonovska, Alan Spearot, Viktor Tsyrennikov, Carl Walsh, Beiling Yan, and Vivian Yue, as well as many others, for their incredibly helpful discussions. This paper has also benefited from comments from conference/seminar participants at Cornell, AEA-Boston, UC Davis, UC Riverside, UC Santa Barbara, UC Santa Cruz, Santa Clara Univ, Atlanta Fed, Peking Univ, Tsinghua Univ, San Francisco Fed, NBER Summer Institute, USC, Midwest Macro, and Midwest International. I am grateful to the editor, William Barnett, and two anonymous referees for their detailed and constructive comments.

References

REFERENCES

Aguiar, M. and Gopinath, G. (2006) Defaultable debt, interest rates and the current account. Journal of International Economics 69, 64–83.CrossRefGoogle Scholar
Aguiar, M. and Gopinath, G. (2007) Emerging market business cycles: The cycle is the trend. Journal of Political Economics 115, 69–102.CrossRefGoogle Scholar
Aizenman, J. and Marion, N. (2004) The merits of horizontal versus vertical FDI in the presence of uncertainty. Journal of International Economics 62, 125–148.CrossRefGoogle Scholar
Alessandria, G., Kaboski, J. and Midrigan, V. (2010) Inventories, lumpy trade, and large devaluations. American Economic Review 100(5), 2304–2339.CrossRefGoogle Scholar
Alessandria, G., Pratap, S. and Yue, V. (2014) Export Dynamics in Large Devaluations. Working Paper.CrossRefGoogle Scholar
Antras, P. and Helpman, E. (2004) Global sourcing. Journal of Political Economy 112(3), 552–580.CrossRefGoogle Scholar
Arellano, C. (2008) Default risk and income fluctuations in emerging economies. American Economic Review 98(3), 690–712.CrossRefGoogle Scholar
Arellano, C. and Kocherlakota, N. (2014) Internal debt crises and sovereign defaults. Journal of Monetary Economics 68(S), S68–S80.CrossRefGoogle Scholar
Asonuma, T. (2014) Sovereign Defaults, External Debt and Real Exchange Rate Dynamics. IMF Working Papers: No. 16/37.Google Scholar
Asonuma, T., Chamon, M. and Sasahara, A. (2016) Trade Costs of Sovereign Debt Restructurings: Does a Market-Friendly Approach Improve the Outcome?” IMF Working Papers: No. 16/222.Google Scholar
Backus, D., Kehoe, P. and Kydland, F. (1992) International real business cycles. Journal of Political Economy 100(4), 745–775.CrossRefGoogle Scholar
Backus, D., Kehoe, P. and Kydland, F. (1994) Dynamics of the trade balance and the terms of trade: The J-curve? American Economic Review 84(1), 84–103.Google Scholar
Bai, Y. and Zhang, J. (2012) Financial integration and international risk sharing. Journal of International Economics 86, 17–32.CrossRefGoogle Scholar
Baldwin, R. and Giavazzi, F. (2015) The Eurozone Crisis - A Consensus View of the Causes and a Few Possibile Remedies. CEPR Press, A VoxEU.org e-Book at http://www.voxeu.org/content/eurozone-crisis-consensus-view-causes-and-few-possible-solutions.Google Scholar
Baldwin, R. and Krugman, P. (1989) Persistent trade effects of large exchange rate shocks. Quarterly Journal of Economics 104(4), 821–854.CrossRefGoogle Scholar
Bergin, P. R. (2006) How well can the new open economy macroeconomics explain the exchange rate and current account? Journal of International Money and Finance 25(5), 675–701.CrossRefGoogle Scholar
Bleaney, M. (2008) The terms of trade, repudiation and default on sovereign debt. Economics Bulletin 6(22), 1–8.Google Scholar
Bodenstein, M. (2008) International asset markets and real exchange rate volatility. Review of Economic Dynamics 11(3), 688–705.CrossRefGoogle Scholar
Bowen, H. P., Leamer, E. and Sveikauskas, L. (1987) Multicountry, multifactor tests of the factor abundance theory. American Economic Review 77(5), 791–809.Google Scholar
Brennan, M. and Cao, H. (1997) International portfolio investment flows. Journal of Finance 52, 1851–1880.CrossRefGoogle Scholar
Broda, C. (2004) Terms of trade and exchange rate regimes in developing countries. Journal of International Economics 63(1), 31–58.CrossRefGoogle Scholar
Broner, F., Didier, T., Erce, A. and Schmukler, S. (2013) Gross capital flows: Dynamics and crises. Journal of Monetary Economics 60, 113–133.CrossRefGoogle Scholar
Bulow, J. and Rogoff, K. (1989) A constant recontracting model of sovereign debt. Journal of Political Economy 97(1), 155–178.CrossRefGoogle Scholar
Chari, V. V., Kehoe, P. J. and McGrattan, E. R. (2002) Can sticky price models generate volatile and persistent real exchange rates? Review of Economic Studies 69(3), 533–563.CrossRefGoogle Scholar
Cuadra, G. and Sapriza, H. (2006) Sovereign Default, Terms of Trade and Interest Rates in Emerging Markets. Banco de México, Working Papers: No. 2006-01.Google Scholar
Drozd, L. and Nosal, J. (2012) Understanding international prices: Customers as capital. American Economic Review 102(1), 364–395.CrossRefGoogle Scholar
Eaton, J.and Gersovitz, M. (1981) Debt with potential repudiation: Theoretical and empirical analysis. Review of Economic Studies 48, 289–309.CrossRefGoogle Scholar
Engel, C. and Wang, J. (2011) International trade in durable goods: Understanding volatility, cyclicality, and elasticities. Journal of International Economics 83(1), 37–52.CrossRefGoogle Scholar
Feenstra, R. C., Luck, P., Obstfeld, M. and Russ, K. N. (2014) In Search of Armington Elasticity. NBER Working Papers: No. 20063.CrossRefGoogle Scholar
Fuentes, M. and Saravia, D. (2010) Sovereign defaulters: Do international capital markets punish them? Journal of Development Economics 91, 336–347.CrossRefGoogle Scholar
Gelos, G., Sahay, R. and Sandleris, G. (2011) Sovereign borrowing by developing countries: What determines market Access? Journal of International Economics 83(2), 243–254.CrossRefGoogle Scholar
Gopinath, G. and Neiman, B. (2014) Trade adjustment and productivity in large crises. American Economic Review 104(3), 793–831.CrossRefGoogle Scholar
Heathcote, J. and Perri, F. (2002) Financial autarky and international business cycles. Journal of Monetary Economics 49(3), 601–627.CrossRefGoogle Scholar
Iacoviello, M. and Minetti, R. (2006) International business cycles with domestic and foreign lenders. Journal of Monetary Economics 53(8), 2267–2282.CrossRefGoogle Scholar
Kehoe, P. and Perri, F. (2002) International business cycles with endogenous incomplete markets. Econometrica 70(3), 907–928.CrossRefGoogle Scholar
Kose, A. (2002) Explaining business cycles in small open economies: How much do world prices matter? Journal of International Economics 56(2), 299–327.CrossRefGoogle Scholar
Krugman, P. (1980) Scale economies, product differentiation, and the pattern of trade. American Economic Review 70(5), 950–959.Google Scholar
Laeven, L. and Valencia, F. (2018) Systemic Banking Crises Revisited. IMF Working Papers: No. 18/206.CrossRefGoogle Scholar
Li, N. (2011) Cyclical wage movements in emerging markets compared to developed economies: The role of interest rates. Review of Economic Dynamics 14, 686–704.CrossRefGoogle Scholar
Lizarazo, S. V. (2013) Default risk and risk averse international investors. Journal of International Economics 89, 317–330.CrossRefGoogle Scholar
Lubker, M. (2007) Labour shares. Policy Brief, Policy Integration Department, International Labour Office (ILO).Google Scholar
Martinez, J. V. and Sandleris, G. (2011) Is it punishment? Sovereign defaults and the decline in trade. Journal of International Money and Finance 30(6), 909–930.CrossRefGoogle Scholar
Mendoza, E. G. (1995) The terms of trade, the real exchange rate, and economic fluctuation. International Economic Review 36(1), 101–137.CrossRefGoogle Scholar
Mendoza, E. G. (2002) Credit, Prices and Crashes: Business Cycles with a Sudden Stop. Chapter 7 of Preventing Currency Crises in Emerging Markets, University of Chicago Press.CrossRefGoogle Scholar
Mendoza, E. G. (2010) Sudden stops, financial crises and leverage. American Economic Review 100, 1941–1966.CrossRefGoogle Scholar
Mendoza, E. G. and Arellano, C. (2003) Credit frictions and ‘Sudden Stops’ in small open economies: An Equilibrium Business Cycle Framework for Emerging Markets Crises. Chapter 7 of Dynamic Macroeconomic Analysis: Theory and Policy in General Equilibrium, Cambridge University Press.Google Scholar
Mendoza, E. G. and Yue, V. (2012) A general equilibrium model of sovereign default and business cycles. Quarterly Journal of Economics 127(2), 889–946.CrossRefGoogle Scholar
Milesi-Ferretti, G. and Tille, C. (2010) The great retrenchment: International capital flows during the global financial crisis. Economic Policy 66, 285–330.Google Scholar
Na, S., Schomitt-Grohe, S., Uribe, M. and Yue, V. (2018) The twin Ds: Optimal default and devaluation. American Economic Review 108(7), 1773–1819.CrossRefGoogle Scholar
Ostry, J. and Reinhart, C. (1992) Private saving and terms of trade shocks: Evidence from developing countries. International Monetary Fund Staff Papers 39(3), 495–517.CrossRefGoogle Scholar
Popov, S. V. and Wiczer, D. G. (2014) Equilibrium Sovereign Default with Exchange Rate Depreciation. Federal Reserve Bank of St. Louis Working Paper Series: No. 2014-049A.CrossRefGoogle Scholar
Raffo, A. (2008) Net exports, consumption volatility and international business cycle models. Journal of International Economics 75(1), 14–29.CrossRefGoogle Scholar
Reinhart, C. M. (2010) This Time is Different: Country Histories on Debt, Default, and Financial Crises. NBER Working Papers: No. 15815.CrossRefGoogle Scholar
Reinhart, C. M. and Rogoff, K. S. (2011) From financial crash to debt crisis. American Economic Review 101(5), 1676–1706.CrossRefGoogle Scholar
Richmond, C. and Dias, D. A. (2009) Duration of Capital Market Exclusion: An Empirical Investigation (July 1, 2009). Available at SSRN: https://ssrn.com/abstract=1027844 or http://dx.doi.org/10.2139/ssrn.1027844.CrossRefGoogle Scholar
Rose, A. K. (2005) One reason countries pay their debts: Renegotiation and international trade. Journal of Development Economics 77(1), 189–206.CrossRefGoogle Scholar
Rose, A. K. and Spiegel, M. (2004) A Gravity Model of Sovereign Lending: Trade, Default, and Credit. IMF Staff Papers, vol. 51(s1), pp. 50–63. Palgrave Macmillan.Google Scholar
Ruhl, J. K. (2008) The Elasticity Puzzle in International Economics. Mimeo, University of Texas at Austin.Google Scholar
Schott, P. K. (2003) One size fits all? Heckscher–Ohlin specialization in global production. American Economic Review 93(3), 686–708.CrossRefGoogle Scholar
Stockman, A. and Tesar, L. (1995) Tastes and technology in a two-country model of the business cycle: Explaining international co-movements. American Economic Review 85(1), 168–185.Google Scholar
Tauchen, G. and Hussey, R. (1991) Quadrature-based methods for obtaining approximate solutions to nonlinear asset pricing models. Econometrica 59(2), 371–396.CrossRefGoogle Scholar
Tille, C. and van Wincoop, E. (2008) International capital flows. Journal of International Economics 80, 157–175.CrossRefGoogle Scholar
Tomz, M. and Wright, M. (2013) Empirical research on sovereign debt and default. Annual Review of Economics, Annual Reviews 5(1), 247–272.CrossRefGoogle Scholar
United Nations Economic Commission for Latin America and the Caribbean (2013) Foreign Direct Investment in Latin America and Caribbean. United Nations: Santiago, Chile.Google Scholar
Yue, V. Z. (2010) Sovereign default and debt renegotiation. Journal of International Economics 80, 176–187.CrossRefGoogle Scholar
Zymek, R. (2012) Sovereign default, international lending, and trade. IMF Economic Review 60, 365–394.CrossRefGoogle Scholar
Supplementary material: PDF

Gu supplementary material

Online Appendix
Download Gu supplementary material(PDF)
PDF 458.1 KB