Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/154273 
Year of Publication: 
2015
Series/Report no.: 
ECB Working Paper No. 1840
Publisher: 
European Central Bank (ECB), Frankfurt a. M.
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 macro-economy. 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: 
Bank-sovereign link
Domestic debt
Interbank market
Non-Ricardian effects
Occasionally binding constraint
Secondary markets
Sovereign default
JEL: 
E43
E44
F34
H63
ISBN: 
978-92-899-1653-0
Document Type: 
Working Paper

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