The Welfare Cost of Sovereign Default and Liquidity Injections

Stellenbosch Working Paper Series No. WP12/2014
 
Publication date: 2014
 
Author(s):
[protected email address] (Department of Economics, University of Stellenbosch)
 
Abstract:

This paper develops a dynamic general equilibrium model with endogenous default on entrepreneur loans and funds borrowed from the central bank (liquidity injections) and investigates the welfare cost of sovereign default. The results show that sovereign default affects production through households' investment decisions and the bank's asset portfolio adjustment. The effect of sovereign default on entrepreneurs tends to be in favor of production. Sovereign default reduces the variability of the output gap and hence the welfare loss. Liquidity injections reduce the variability of the output gap and improve price stability during the period of sovereign debt crisis, resulting in an increase in households' welfare.

 
JEL Classification:

E50, E58, E63, G18

Keywords:

sovereign default, welfare cost, debt crisis, rollover risk, liquidity

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BER Weekly

17 February 2020
Last Thursday, President Ramaphosa delivered his State of the Nation address (Sona) to parliament. The statement gave recognition to the economic challenges SA currently face, especially regarding electricity supply. More emphasis was placed on the role of the private sector to help solve these challenges. Read more in the Current affairs section. On...

Read the full issue