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RIETI International Workshop International Monetary Fund (IMF) Research Institute of Economy, Trade and Industry (RIETI) https://www.rieti.go.jp/en/index.html Tamon Asonuma Long-term Growth and Secular Stagnation Handout March 30, 2018

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Page 1: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

RIETI International Workshop

International Monetary Fund (IMF)

Research Institute of Economy, Trade and Industry (RIETI)https://www.rieti.go.jp/en/index.html

Tamon Asonuma

Long-term Growth and Secular Stagnation

Handout

March 30, 2018

Page 2: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Sovereign Debt Overhang, ExpenditurePortfolio and Debt Restructurings

Tamon Asonuma and Hyungseok Joo

IMF and WSU

RIETI International WorkshopLong-term growth and secular stagnation

March 30 2018

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 1 / 46

Page 3: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Disclaimer

The views expressed herein are those of the authors and shouldnot be attributed to the IMF, its Exercutive Board, or itsmanagement.

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 2 / 46

Page 4: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

New data on public expenditure portfolio

179 privately-held external debt restructurings in 1978–2010(Asonuma and Trebesch 2016)

New dataset on public expenditure portfolio

Public consumption (public sector wage bills and consumption onfinal goods and service)Public transfersPublic investmentPublic capital (assets)

Sources of our dataset

IMF Staff Reports from the IMF archives (more than 500 reports)IMF FAD and WEOWB WDI

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 3 / 46

Page 5: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Our new dataset

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 4 / 46

Page 6: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Stylized facts on restructurings

Stylized Fact 1: Public investment experiences a severe declineand slow recovery, while public consumption and transfersexperience short-lived declines and quick recovery.

Figure: Public consumption (level,start=100)

Figure: Public investment (level,start=100)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 5 / 46

Page 7: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Stylized facts on restructurings (cont.)

Figure: Public transfer (level,start=100)

Figure: GDP per capita (level,start=100)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 6 / 46

Page 8: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Stylized facts on restructurings (cont.)

Public consumption and investment are procyclical with significance,while transfers are acyclical.

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 7 / 46

Page 9: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Stylized facts on restructurings (cont.)

Stylized Fact 2: Sovereigns decelerate public capitalaccumulation during restructurings.

Figure: Public capital (growth rate%)Figure: Public capital (level,start=100)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 8 / 46

Page 10: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Stylized facts on restructurings (cont.)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 9 / 46

Page 11: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Stylized facts on restructurings (cont.)

Stylized Fact 3: Public investment is negatively associated with publicexternal debt with significance, but neither public consumption nortransfers is.

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 10 / 46

Page 12: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Stylized facts on restructurings (cont.)

Stylized Fact 1: Public investment experiences a severe declineand slow recovery, while public consumption and transfersexperience short-lived declines and quick recovery. (Bothconsumption and investment are procyclical, while transfers areacylical.)

Stylized Fact 2: Sovereigns decelerate public capitalaccumulation during restructurings.

Stylized Fact 3: Public investment is negatively associated withpublic external debt with significance, but neither publicconsumption nor transfer is.

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 11 / 46

Page 13: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Main questions

Main questions

Why do the sovereign debtors experience a severe decline and slowrecovery in public investment (i.e. deceleration of public capitalaccumulation) around debt restructurings?In contrast, why do they experience short-lived declines and quickrecovery in public consumption and transfers?

Question on the big puzzle in the literature

How does public capital influence sovereign debtors’ decision todefault, to delay the renegotiations, and to agree on settlement?

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 12 / 46

Page 14: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Implications of the paper

New dataset on public expenditure portfolio and new stylized factson debt overhang, expenditure portfolio and restructurings:

A severe decline in public investment, while short-lived declines inpublic consumption and transfers.Deceleration of public capital accumulation.Negative association between public investment and external debt.

Theoretical model with (i) public expenditure portfolio, (ii) publiccapital accumulation, and (iii) multi-round debt renegotiationrationalizes these facts:

A severe decline in public investment, while a short-lived decline inpublic consumption/transfers.Deceleration of public capital accumulation.Negative association between public investment and external debt.

The data confirms the main prediction of the theoretical model.

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 13 / 46

Page 15: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Intuition: Main mechanism and drivers

Prior to restructurings: Low productivity, high debt payments,and consumption-smoothing motive.

On the one hand, sovereigns opt to smooth both private and publicconsumption (through transfers and public consumption).On the other hand, sovereigns distortionally reduce publicinvestment.

During restructurings: Deceleration of public capitalaccumulation and lengthy negotiations.

Public capital accumulation is slow due to low productivity and noexternal borrowing.Sovereigns opt to delay the settlement since they prioritizeinvestment to public capital (high MPK).Sovereigns choose to settle with debt repayments after publiccapital accumulation (low MPK).

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 14 / 46

Page 16: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Literature review

Sovereign debt overhang

Krugman (1989), Sach (1989), Aguiar et al. (2009), Ostry et al.(2014), Reinhart et al. (2012)

Public expenditure portfolio

Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al.(2017), Bianchi et al. (2017), Azzimonti (2015), Mendoza et al.(2014)

Sovereign defaults and renegotiations (multi-round)

Benjamin and Wright (2009), Kovrijnykh and Szentes (2007), Baiand Zhang (2012), Bi (2008), Asonuma and Joo (2017)

Sovereign debt and capital

Gordon and Guerron-Quantina (2017), Park (2017)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 15 / 46

Page 17: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Model: General features

Sovereign debt in a dynamic small open economy model:

Public expenditure portfolio,Public capital accumulation,Production with labor and public capital,Multi-round debt renegotiation.

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 16 / 46

Page 18: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Model: General features (Cont.)

A risk averse sovereign debtor, a household, a private firm andrisk-neural creditors

A stochastic TFP shock at

Public expenditure choice: consumption, investment, transfers anddebt repayments

Public capital accumulation and elastic labor supply

Credit record ht : indicating status of market access

Incomplete capital market: one-period zero-coupon bonds

One-side commitment

Multi-round renegotiation upon the default choice

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 17 / 46

Page 19: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Model: Timing

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 18 / 46

Page 20: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Model: Household’s problem

Household maximization problem

maxct,lt

E0

∞∑t=0

βtU(ct, lt, gt) (1)

s.t. (1 + τ)ct = wtlt + πFt + Tt (2)

where U(ct, lt, gt) = (1− λ)u(ct, lt) + λv(gt)

Optimality condition of household

ul(ct, lt)

uc(ct, lt)=

wt1 + τ

(3)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 19 / 46

Page 21: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Model: Firm’s problem

Production function

yt = at(lt)αl(kgt )

αk(kp)1−αl−αk (4)

where kp = 1(Mendoza and Yue 2012, Azzimonti 2015)

Private firm’s profit maximization problem:

maxlt

πFt = at(lt)αl(kgt )

αk(kp)1−αl−αk − wtlt (5)

Optimality condition of the private firm

wt = αlat(lt)αl−1(kgt )

αk(kp)1−αl−αk (6)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 20 / 46

Page 22: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Model: Sovereign’s problem (cont.)

Case of good credit record (market access - ht = 0)If the sovereign has debt (bt < 0)

V (bt, kgt , 0, at) = max

[V R(bt, k

gt , 0, at), V

D(bt, kgt , 0, at)

](12)

Sovereign’s value of repayment

V R(bt, kgt , 0, at) = max

gt,bt+1,kgt+1,Tt

(1− λ)u(ct, lt) + λv(gt)

∫A

V (bt+1, kgt+1, 0, at+1)dµ(at+1|at) (7’)

s.t. gt+kgt+1+Tt+q(bt+1, k

gt+1, 0, at)bt+1 = τct+(1−δg)kgt−

Ω

2(kgt+1 − k

gt

kgt)2kgt+bt

(8)Tt ≥ 0 (9)

ul(ct, lt)

uc(ct, lt)=αlat(lt)

αl−1(kgt )αk (kp)1−αl−αk

1 + τ(10)

(1 + τ)ct = yt + Tt (11)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 21 / 46

Page 23: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Model: Sovereign’s problem (cont.)

Sovereign’s value of defaulting (restructuring)

V D(bt, kgt , 0, at) = max

gt,bt+1,kgt+1,Tt

(1− λ)u(ct, lt) + λv(gt)

∫A

V ((1 + r∗)bt, kgt+1, 1, at+1)dµ(at+1|at) (13)

s.t. gt + kgt+1 + Tt = τct + (1− δg)kgt −Ω

2(kgt+1 − k

gt

kgt)2kgt (8’)

Tt ≥ 0 (9)

ul(ct, lt)

uc(ct, lt)=αlat(lt)

αl−1(kgt )αk (kp)1−αl−αk

1 + τ(10’)

(1 + τ)ct = yt + Tt (11’)

Case of bad credit record (loss in access - ht = 1)

V (bt, kgt , 1, at) = Γ(bt, k

gt , at) (14)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 22 / 46

Page 24: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Model: Renegotiation problem

Strategies of the proposer i and the other party j (for i, j = B,L) dependingon state (bt, k

gt , ht, at) and current offer:

θi = 1 (propose) & θj = 1 (accept)

θi = 0 (pass) & θj = 0 (reject)Case when the borrower B is the proposer

If B proposes and the proposal is

VPRO

(bt, kgt , at) = max

gt,kgt+1

,Tt

(1− λ)u(ct, lt) + λv(gt) + β

∫AV (0, k

gt+1, 0, at+1)dµ(at+1|at)

(18)

s.t. gt + kgt+1 + Tt = τct + (1− δg)kgt −Ω

2(kgt+1 − k

gt

kgt)2kgt + δBt bt (8”)

Tt ≥ 0 (9)

ul(ct, lt)

uc(ct, lt)=αlat(lt)

αl−1(kgt )αk (kp)1−αl−αk

1 + τ(10’)

(1 + τ)ct = yt + Tt (11’)

V ∗ACT (bt, kgt , at) = −δBt bt (19)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 23 / 46

Page 25: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Model: Renegotiation problem (cont.)

If B passes,

V PASS(bt, kgt , at) = max

gt,kgt+1,Tt

(1− λ)u(ct, lt) + λv(gt)

+ β

∫A

V ((1 + r∗)bt, kgt+1, 1, at+1)dµ(at+1|at) (20)

s.t. gt + kgt+1 + Tt = τct + (1− δg)kgt −Ω

2(kgt+1 − k

gt

kgt)2kgt (8’)

Tt ≥ 0 (9)

ul(ct, lt)

uc(ct, lt)=αlat(lt)

αl−1(kgt )αk(kp)1−αl−αk

1 + τ(10’)

(1 + τ)ct = yt + Tt (11’)

V ∗REJ(bt, kgt , at) =

1

1 + r∗

∫A

Γ∗((1 + r∗)bt, kgt+1, 1, at+1)dµ(at+1|at)

(21)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 24 / 46

Page 26: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Model: Renegotiation problem (cont.)

EquilibriumδB∗t = argmaxV PRO(bt, k

gt , at)

s.t. V PRO(bt, kgt , at) ≥ V PASS(bt, k

gt , at)

V ∗ACT (bt, kgt , at) ≥ V ∗REJ(bt, k

gt , at) (22)

If both parties reach an agreement,

ΓB(bt, kgt , at) = V PRO(bt, k

gt , at) (23)

ΓB∗(bt, kgt , at) = V ∗ACT (bt, k

gt , at) (24)

Otherwise,ΓB(bt, k

gt , at) = V PASS(bt, k

gt , at) (23’)

ΓB∗(bt, kgt , at) = V ∗REJ(bt, k

gt , at) (24’)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 25 / 46

Page 27: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Equilibrium

Definition

A recursive equilibrium is defined as a set of functions for (a) the sovereign’svalue function, pubic consumption, transfers, capital, assets/debt, default set,(b) the household’s consumption and labor supply, (c) the firm’s labordemand, (d) the sovereign’s and the creditors’ decision functions, payoffs, twosets of recovery rates, and (e) sovereign bond prices such that[1]. the sovereign government’s value function, public consumption, capital,transfers, assets/debt, and default set satisfy its optimization problem(7)–(15);[2]. the household’s consumption and labor supply satisfy his optimizationproblem (1)–(3);[3]. the firm’s labor demand satisfies its optimization problem (4)–(6);[4]. both parties’ decisions, payoffs and recovery rates solve the multi-rounddebt renegotiation problem (16)–(33);[5]. sovereign prices satisfy the foreign creditors’ optimization problem(34)–(35).

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 26 / 46

Page 28: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Quantitative analysis - Parameters

TFP process -AR(1) process:

log(at) = ρ log(at−1) + εt, (41)

Household utility function - GHH, CRRA:

u(ct, lt) =(ct − l

1+ψt1+ψ

)1−σ

1− σ , v(gt) =g1−σgt

1− σg(40)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 27 / 46

Page 29: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Quantitative analysis - Steady-state dist.

Sovereign’s choice among repayment, delay and settlement

0

0.2

0.4

0.6

0.8

1

−0.1

−0.05

0

0.05

0.1

DebtProductivity Repayment

Delay

Settlement

Figure: Mean public capital

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 28 / 46

Page 30: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Quantitative analysis - Steady-state dist. (cont.)

Sovereign’s choice among repayment, delay and settlement

0

0.5

1

−0.1

0

0.1

DebtProductivity

Figure: Low public capital

0

0.5

1

−0.1

0

0.1

DebtProductivity

Figure: High public capital

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 29 / 46

Page 31: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Quantitative analysis - Steady-state dist. (cont.)

Public consumption/transfers – Mean public capital

0

0.5

1

−0.1

0

0.1

0

0.1

0.2

0.3

0.4

DebtProductivity

Pu

bC

on

/Tra

nsfe

r

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

Figure: “Repayment” Region

0

0.5

1

−0.1

0

0.1

0

0.1

0.2

0.3

0.4

DebtProductivity

Pu

bC

on

/Tra

nsfe

r0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

Figure: “Settlement” and “Delay”Region

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 30 / 46

Page 32: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Quantitative analysis - Steady-state dist. (cont.)

Public investment – Mean public capital

0

0.5

1

−0.1

0

0.1

−0.05

0

0.05

DebtProductivity

Pu

blic

In

ve

stm

en

t

−0.08

−0.06

−0.04

−0.02

0

0.02

0.04

0.06

Figure: “Repayment” Region

0

0.5

1

−0.1

0

0.1

−0.05

0

0.05

DebtProductivity

Pu

blic

In

ve

stm

en

t−0.08

−0.06

−0.04

−0.02

0

0.02

0.04

0.06

Figure: “Settlement” and “Delay”Region

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 31 / 46

Page 33: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Quantitative analysis - Simulation

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 32 / 46

Page 34: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Quantitative analysis - Simulation (Cont.)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 33 / 46

Page 35: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Testing the model predictions

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 34 / 46

Page 36: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Conclusion

New dataset on public expenditure portfolio and new stylized factson debt overhang, expenditure portfolio and restructurings

A severe decline in public investment, while short-lived declines inpublic consumption and transfers.Deceleration of public capital accumulation.Negative association between public investment and external debt.

Theoretical model with (i) public expenditure portfolio, (ii) publiccapital accumulation, and (iii) multi-round debt renegotiationrationalizes these facts:

A severe decline in public investment, while a short-lived decline inpublic consumption/transfers.Deceleration of public capital accumulation.Negative association between public investment and external debt.

The data confirms the main prediction of the theoretical model.

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 35 / 46

Page 37: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Stylized facts on restructurings (cont.)

Different dynamics of private consumption and investment withthose of public consumption and investment.

Figure: Public and private investment(level, start=100)

Figure: Public and privateconsumption (level, start=100)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 36 / 46

Page 38: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Overview of the paper

Empirical, theoretical and quantitative analysis of sovereign debt.

Two main contributions to the literature on sovereign debt.

New dataset on public expenditure portfolio and new stylized factson debt overhang, expenditure portfolio and restructurings.New theoretical explanations on sovereign debt overhang and delaysin debt restructurings.

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 37 / 46

Page 39: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Stylized facts on restructurings (cont.)

Stylized Fact 3: Public investment is negatively associated with publicexternal debt with significance, but neither public consumption nortransfers is.

010

20

30

40

Public C

onsum

ption (

curr

ent, %

of G

DP

)

0 40 80 120 160 200PPG External Debt (lagged, % of GDP)

Observation Regression Line

Figure: Public consumption (% ofGDP)

05

10

15

20

Public Investm

ent (c

urr

ent, %

of G

DP

)0 40 80 120 160 200

PPG External Debt (lagged, % of GDP)

Observation Regression Line

Figure: Public investment (% ofGDP)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 38 / 46

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Stylized facts on restructurings (cont.)

05

1015

20Pu

blic T

rans

fers

(cur

rent

, % o

f GDP

)

0 40 80 120 160 200PPG External Debt (lagged, % of GDP)

Observation Regression Line

Figure: Public transfer (% of GDP)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 39 / 46

Page 41: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Model: Sovereign’s problem

If the sovereign has saving (bt ≥ 0)

V (bt, kgt , 0, at) = max

gt,bt+1,kgt+1,Tt

(1− λ)u(ct, lt) + λv(gt)

∫A

V (bt+1, kgt+1, 0, at+1)dµ(at+1|at) (7)

s.t. gt+kgt+1+Tt+q(bt+1, k

gt+1, 0, at)bt+1 = τct+(1−δg)kgt−

Ω

2(kgt+1 − k

gt

kgt)2kgt+bt

(8)Tt ≥ 0 (9)

ul(ct, lt)

uc(ct, lt)=αlat(lt)

αl−1(kgt )αk (kp)1−αl−αk

1 + τ(10)

(1 + τ)ct = yt + Tt (11)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 40 / 46

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Model: Creditor’s problem

Expected profit

πc(bt+1, k

gt+1, 0, at) =

q(bt+1, kgt+1, 0, at)bt+1 − 1

1+r∗ bt+1, if bt+1≥0

[1−pD(bt+1,k

gt+1

,0,at)

1+r∗ +

pD(bt+1,kgt+1

,0,at)∫A γ(bt+1,k

gt+1

,1,at)dµ(at+1|at)1+r∗ ](−bt+1)

−q(bt+1, kgt+1, 0, at)(−bt+1), otherwise

(34)

Equilibrium bond price

q(bt+1, kgt+1, 0, at) =

11+r∗ if bt+1≥0

1−pD(bt+1,kgt+1,0,at)

1+r∗

+pD(bt+1,k

gt+1,0,at)

∫A γ(bt+1,k

gt+1,1,at)dµ(at+1|at)

1+r∗ otherwise

(35)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 41 / 46

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equilibrium

Default probability

pD(bt+1, kgt+1, 0, at) =

∫D(bt+1,k

gt+1)

dµ(at+1|at), (36)

Expected recovery rates

γ(bt+1, kgt+1, 1, at) =

∫Aγ(bt+1, k

gt+1, 1, at+1)dµ(at+1|at)

=

∫A

φ1at+1∈RB(bt+1,k

gt+1)

δB∗t (bt+1, kgt+1, at+1)

+(1− φ)1at+1∈RL(bt+1,kgt+1)

δL∗t (bt+1, kgt+1, at+1)

+

(φ1at+1 /∈RB(bt+1,k

gt+1)

+(1− φ)1at+1 /∈RL(bt+1,kgt+1)

)γ(bt+2, k

gt+2, 1, at+1)

dµ(at+1|at)

(38)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 42 / 46

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equilibrium

Probability of settling the deal

pR(bt+1, kgt+1, at) = φ

∫RB(bt+1,k

gt+1)

dµ(at+1|at)+(1−φ)

∫RL(bt+1,k

gt+1)

dµ(at+1|at)

(37)

Sovereign bond spreads

s(bt+1, kgt+1, 0, at) =

1

q(bt+1, kgt+1, 0, at)

− (1 + r∗) (39)

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 43 / 46

Page 45: Sovereign Debt Overhang, Expenditure Portfolio and Debt ...Public expenditure portfolio Arellano and Bai (2016), Cuadra et al. (2010), Hatchondo et al. (2017), Bianchi et al. (2017),

Quantitative analysis - Steady-state dist. (cont.)

Public consumption/transfers

0

0.5

1

−0.1

0

0.1

0

0.1

0.2

0.3

0.4

DebtProductivity

Pu

bC

on

/Tra

nsfe

r

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

Figure: Low Public Capital

0

0.5

1

−0.1

0

0.1

0

0.1

0.2

0.3

0.4

DebtProductivity

Pu

bC

on

/Tra

nsfe

r0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

Figure: High Public Capital

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 44 / 46

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Quantitative analysis - Steady-state dist. (cont.)

Public investment

0

0.5

1

−0.1

0

0.1

−0.05

0

0.05

DebtProductivity

Pu

blic

In

ve

stm

en

t

−0.08

−0.06

−0.04

−0.02

0

0.02

0.04

0.06

Figure: Low Public Capital

0

0.5

1

−0.1

0

0.1

−0.05

0

0.05

DebtProductivity

Pu

blic

In

ve

stm

en

t−0.08

−0.06

−0.04

−0.02

0

0.02

0.04

0.06

Figure: High Public Capital

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 45 / 46

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Quantitative analysis - Steady-state dist. (cont.)

Agreed recovery rates

0

0.5

1

−0.1

0

0.1

0

0.1

0.2

0.3

0.4

0.5

DebtProductivity

Figure: Mean Public Capital

0

0.5

1

−0.1

0

0.1

0

0.1

0.2

0.3

0.4

0.5

DebtProductivity

Figure: High Public Capital

Asonuma & Joo (IMF and WSU) Sovereign Debt Restructurings March 30 2018 46 / 46