The Welfare Cost of Sovereign Default and Liquidity Injections
Stellenbosch Working Paper Series No. WP12/2014Publication date: 2014
Author(s):
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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Prof Euan Phimister: Stellenbosch Business School
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Topic: "Allocative Efficiency, Labour Shares, and Corporate Lobbying in European Manufacturing"
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26 Sep 2025 Free Weekly Review | Number 37 | 26 SeptemberThis report covers the key domestic and international data releases over the past week. The more comprehensive BER Weekly Review (Enhanced Version) includes a detailed discussion on the main economic events and developments over the past week, a summary of upcoming data (the week ahead) and the BER’s forecast for key economic indicators....
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