Essays on International Macroeconomics

Abstract

This dissertation consists of three chapters. In the first chapter, I document thatSpain had a private sector debt boom leading up to the financial crisis and an increase in private sector defaults and subsequent deleveraging thereafter. However, the government sharply increased its debt during the crisis. I build a model torationalize these facts. In my model both firms and the government have limited commitment to repay and borrow from external lenders. Default is costly both for firms and the government. In the crisis that I simulate, I am able to replicate higher default rates and deleveraging of firms as in the data. However, in my model the government also reduces its debt which is contrary to what is seen in the data. In the second chapter, I document that following the formation of the European Monetary Union (EMU), there was a boom in external sovereign debt in Greece, Portugal and Italy. I analyze Greece, for which I observe that expectations of as well as realized GDP growth were significantly higher in the first decade after joining the EMU. I calibrate a sovereign default model to resemble the Greek economy prior to joining the EMU. I then re-estimate GDP parameters using data only during the subsequent boom that followed Greece’s accession to EMU and simulate my model with the new output process, keeping all other parameters unchanged. I find that the output boom only accounts for 33% of the debt boom between 1999 and 2008. In chapter 3, I document that contemporaneous with the sovereign debt boom, there was also a boom in holdings of the sovereign bonds of Greece, Portugal and Italy by banks within the EMU. I argue that banks’ large sovereign bond holdings created expectations of bailouts amongst non-bank investors, leading to suppressed spreads and the subsequent debt boom. I analyze Greece and document that EMU banks’ holdings of Greek sovereign debt increased six fold after Greece joined the EMU. I build a sovereign default model with a bailout authority whose objective is to maximize the net worth of banks in the EMU net of the costs of enacting bailouts. I model banks’ bond holdings as in the data and find that this model accounts for 55% of the Greek debt boom from 1999 to 2008. This finding suggests a re-evaluation of banking regulations in the EMU that encourage holding sovereign bonds of member countries.