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SOVEREIGN DEFAULT, TRADE, AND TERMS OF TRADE

Published online by Cambridge University Press:  02 September 2019

Grace Weishi Gu
Grace Weishi Gu*
Affiliation:
UC Santa Cruz
*
Address correspondence to: Grace Weishi Gu, Department of Economics, UC Santa Cruz, Engineering 2 Building, Room 463, Santa Cruz, CA 95060, USA. e-mail: grace.gu@ucsc.edu.
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Abstract

Sovereign defaults are associated with income and trade reductions and terms-of-trade deterioration. This paper develops a two-country model to study the interactions between income, trade, terms of trade, and foreign-debt default risk and default events. Such default risk and events are costly because they adversely affect the demand for a borrower country’s intermediate goods exports and its income. Consequently, trade flows change due to the income loss and consumption home bias. The defaulter’s terms of trade also deteriorate endogenously, which accelerates its income and trade losses. The model produces procyclical imports, exports, terms of trade, and other empirical features of emerging countries’ business cycles and default episodes.

Keywords

Sovereign DefaultTerms of TradeTrade FlowsVertical Export
Type
Articles
Information
Macroeconomic Dynamics , Volume 25 , Issue 6 , September 2021 , pp. 1346 - 1380
Copyright
© Cambridge University Press 2019

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Footnotes

I thank George Alessandria, Laura Alfaro, Yan Bai, Paul Bergin, George Bulman, Michael Dooley, Fabio Ghironi, Michael Hutchinson, Ken Kasa, Ken Kletzer, Huiyu Li, Leonardo Martinez, Eswar Prasad, Vincenzo Quadrini, Katheryn Russ, Ina Simonovska, Alan Spearot, Viktor Tsyrennikov, Carl Walsh, Beiling Yan, and Vivian Yue, as well as many others, for their incredibly helpful discussions. This paper has also benefited from comments from conference/seminar participants at Cornell, AEA-Boston, UC Davis, UC Riverside, UC Santa Barbara, UC Santa Cruz, Santa Clara Univ, Atlanta Fed, Peking Univ, Tsinghua Univ, San Francisco Fed, NBER Summer Institute, USC, Midwest Macro, and Midwest International. I am grateful to the editor, William Barnett, and two anonymous referees for their detailed and constructive comments.

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