Thread by @wpaczos

📢New paper alert📢
"Defaulting on #Covid19 Debt: Domestic or Foreign?" my new paper coauthored with Kirill Shakhnov has been published in #CovidEconomics Vetted and Real Time Papers:
bit.ly/3jMqySP
@cepr_org @voxeu
@cardiffbusiness @economicssurrey #EconTwitter
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We start by observing that #CovidShock is special in two respects: is completely unexpected and causes GDP to fall and public expenditure to rise simultaneously and by large margins. The figure is based on IMF WEO June Update, axes are in percentage points:
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We write a problem of a government unsure about productivity and expenditures and has debts to pay. Importantly, there are two debts: foreign and domestic. Taxes are distortionary and it can default on either obligation.
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Two debts are markedly different instruments: foreign default relaxes resource constraint (funds stay at home) domestic default cannot do this. Defaulting is costly: we model it as direct output loss. Problem does not admit analytical solution, so we solve it numerically.
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We find striking result: almost perfect separation of default decisions. Foreign default is optimal after big loss to productivity and domestic default is optimal after big expenditure hike. The graph plots repayment limits for two debts in the productivity-expenditure space
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Positions of repayment lines depend on calibration, but their different slopes, which leads to separation, do not. We conclude that after #CovidShock fragility of emerging economies debts will increase: not only on foreign, but also on domestic market
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G-20 suspended interest payments on bilateral debts. Economists argued for a broad “debt standstill” with private creditors for large set of countries. Our results show this is necessary, but focusing on foreign debt may be insufficient to prevent defaults

https://twitter.com/upanizza/status/1253222165408776192?s=20

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