Essays in Sovereign Default and International Financial Liberalization

Moussa, Racha

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March 22, 2019

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Moussa, Racha
- Affiliation: College of Arts and Sciences, Department of Economics

Abstract

My dissertation is a collection of three papers that deal with the issues of sovereign default and international financial liberalization. The first paper is titled: Debt Denomination, Exchange Rate Regimes, and Sovereign Default. This paper develops a dynamic stochastic open economy model where default occurs in equilibrium to study the welfare impact of abandoning a fixed exchange rate regime before a sovereign default crisis. The implications of abandoning a fixed exchange rate are captured using two key features: sticky nominal wages and foreign-currency denominated debt. Abandoning a fixed exchange rate allows governments to regain monetary independence to pursue employment and output goals. However, the accompanying nominal devaluation increases the external debt burden and the probability of default. Fixed exchange rates, on the other hand, involve a loss of monetary independence but less volatility in the foreign-currency denominated external debt burden. Therefore, in the model, the welfare impact of an exchange rate regime switch prior to sovereign default depends on two countervailing effects: the output effect and the debt burden effect. The second paper is titled: Default, Austerity, and their Relative Costs. This paper uses the model developed in Cuadra et al. (2010) to find thresholds beyond which an increase in austerity is less optimal than default as a method to deal with an unsustainable debt burden. The third paper is titled: Does Capital Scarcity Matter and is joint with Anusha Chari and Peter Blair Henry. This paper quantifies the welfare impact of a permanent increase in the level of per capita income brought about by a temporary increase in the growth rate of GDP per capita following capital account liberalization. In the immediate aftermath of liberalization, and under a range of assumptions, differences between the autarkic and integrated equilibrium consumption paths are large. Yet the welfare impact of these differences is small when using infinite horizon consumption streams to compute welfare. The results suggest that a finite horizon framework may be more appropriate for evaluating the welfare consequences of economic policy changes that induce temporary growth effects but have a permanent impact on the level of per capita incomes.

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