Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/105820
Authors: 
Engler, Philipp
Große Steffen, Christoph
Year of Publication: 
2014
Series/Report no.: 
DIW Discussion Papers 1436
Abstract: 
This paper studies the bank-sovereign link in a dynamic stochastic general equilibrium set-up with strategic default on public debt. Heterogeneous banks give rise to an interbank market where government bonds are used as collateral. A default penalty arises from a breakdown of interbank intermediation that induces a credit crunch. Government borrowing under limited commitment is costly ex ante as bank funding conditions tighten when the quality of collateral drops. This lowers the penalty from an interbank freeze and feeds back into default risk. The arising amplification mechanism propagates aggregate shocks to the macroeconomy. The model is calibrated using Spanish data and is capable of reproducing key business cycle statistics alongside stylized facts during the European sovereign debt crisis.
Subjects: 
Sovereign default
Interbank market
Bank-sovereign link
Non-Ricardian effects
Secondary markets
Domestic debt
Occasionally binding constraint
JEL: 
E43
E44
F34
H63
Document Type: 
Working Paper

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