Throughout history, advanced and emerging economies have been confronted by a multitude of sovereign debt and financial crises. The dramatic surge in public debt in many economies triggered by the recent financial crisis raises the question of the stability and sustainability and leads to concerns about possible adverse consequences for the private sector, particularly for the availability of private credit and thus for investment and economic growth. The objective of this research project is to understand the theoretical mechanisms and quantitative implications of sovereign and private default risks and their interactions on macroeconomic outcomes. To this end, we incorporate debt repudiation in stochastic dynamic general equilibrium models of closed and open economies. The project is organised along three topics. First, we analyse the dynamic properties of fiscal conditionality imposed by international financial institutions on indebted countries in need of financial assistance. We are especially interested in the role of renegotiations on conditionality and how they affect default risks and macroeconomic outcomes. Second, we explore the effects of public debt on the availability of private firm credit and on the capital allocation among heterogeneous firms who are financially constrained and possibly subject to default risk. We study how fiscal deficits are transmitted to the private credit market and to aggregate factor productivity. Third, we consider the relation between sovereign debt and political uncertainty so as to understand how policymakers make strategic use of external debt to manipulate re-election probabilities and how this affects the connection between debt crises and political crises.
