TY  - JOUR
AU  - Arellano, Cristina
AU  - Bai, Yan
AU  - Mihalache, Gabriel
TI  - Default Risk, Sectoral Reallocation, and Persistent Recessions
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 23835
PY  - 2017
Y2  - September 2017
DO  - 10.3386/w23835
UR  - http://www.nber.org/papers/w23835
L1  - http://www.nber.org/papers/w23835.pdf
N1  - Author contact info:
Cristina Arellano
Federal Reserve Bank of Minneapolis
Research Department
90 Hennepin Avenue
Minneapolis, MN 55401
Tel: (612) 204-5276
Fax: (612) 204-5515
E-Mail: arellano.cristina@gmail.com

Yan Bai
Department of Economics
University of Rochester
216 Harkness Hall
Rochester, NY 14627
Tel: 585/275-4196
Fax: 585/256-2309
E-Mail: yanbai06@gmail.com

Gabriel Mihalache
S633, Social and Behavioral Sciences Bld. 
Department of Economics
Stony Brook University
Stony Brook, NY 11794
USA
Tel: 5856273848
E-Mail: gabriel.mihalache@stonybrook.edu
M1  - published as Cristina Arellano, Yan Bai, Gabriel Mihalache. "Default Risk, Sectoral Reallocation, and Persistent Recessions," in Jeffrey Frankel, Hélène Rey, and Charles Engel, organizers, "NBER International Seminar on Macroeconomics 2017" Journal of International Economics (Elsevier), volume 112 (2018)

AB  - Sovereign debt crises are associated with large and persistent declines in economic activity, disproportionately so for nontradable sectors. This paper documents this pattern using Spanish data and builds a two-sector dynamic quantitative model of sovereign default with capital accumulation. Recessions are very persistent in the model and more pronounced for nontraded sectors because of default risk. An adverse domestic shock increases the likelihood of default, limits capital inflows, and thus restricts the ability of the economy to exploit investment opportunities. The economy responds by reducing investment and reallocating capital toward the traded sector to support debt service payments. The real exchange rate depreciates, a reflection of the scarcity of traded goods. We find that these mechanisms are quantitatively important for rationalizing the experience of Spain during the recent debt crisis.
ER  -