Research interests: International Macroeconomics, Sovereign Debt, Financial Frictions

Sovereign Default in a Monetary Union (with Federica Romei)

In the aftermath of the global financial crisis, sovereign default risk and the zero lower bound have limited the ability of policy-makers in the European monetary union to achieve their stabilization objective. This paper investigates the interaction between sovereign default risk and the conduct of monetary policy, when borrowers can act strategically and they share with their lenders a single currency in a monetary union. We address this question in an endogenous sovereign default model of heterogeneous countries in a monetary union, where the monetary authority may be constrained by the zero lower bound. We uncover three main results. First, in normal times, debtors have a stronger incentive to default to induce more expansionary monetary policy. Second, the zero lower bound, or constraints on monetary policy may act as a disciplining device to enforce repayment of sovereign debt. Third, sovereign default risk induces countries with a preference for tight monetary policy to accept a laxer policy stance. These results help to shed light on the recent European experience of high default risk, expansionary monetary policy and low nominal interest rates.

External Imbalances, Gross Capital Flows and Sovereign Debt Crises (submitted)

Abstract: The experience of the European monetary union has been characterized by current account imbalances, widening gross external positions and a severe sovereign debt crisis. I argue that institutional features of the European Economic and Monetary Union have contributed to all three. I show in a model that subsidies on holdings of euro-denominated assets contribute to current account imbalances, to gross capital flows and to the severity of the crisis. In a quantitative model with heterogeneous countries, I show that the subsidies account for a substantial fraction of net and gross capital flows in the euro area.

Sovereign Debt Crises, Fiscal Austerity and Corporate Default 

Abstract: During the Eurozone debt crisis, Italy suffered from an increase in sovereign borrowing costs and from a reduction in credit to firms. What is the link between sovereign default risk and financial frictions faced by firms? To address this question, I build a model of endogenous sovereign default where firms issue risky debt and fiscal policy is distortionary. First, I show that a sovereign debt crisis causes a reduction of credit to firms, occurring through the channel of domestic fiscal policy. A fiscal tightening in the country in crisis causes a reduction of firms' profits and an increase in their default risk. Second, I show that firms are heterogeneous in the degree to which they are affected by a crisis: Firms in the non-tradable sector are more vulnerable, as demand for their output falls in a crisis. Finally, as observed in Italy, a contraction in economic activity occurs during the crisis.

Endogenous Volatility in Sovereign Interest Rates: The Role of Default Risk 

Abstract:  What are the determinants of time-varying interest rate volatility on emerging markets' external debt? I show that a baseline model of endogenous sovereign default quantitatively replicates the pattern of time-varying volatility observed in the data. The model features a key non-linearity in the policy function for the interest rate on external debt. In the absence of shocks to the second moment of stochastic variables, the model generates a path of interest rates that is more volatile in bad times, when output is low and debt is high.


Cross-borrower spillovers in the market for sovereign debt