The Long and the Short of It: Sovereign Debt Crises and Debt Maturity

We present a simple model of sovereign debt crises in which a country chooses its optimal mix of short and long-term debt contracts subject to standard contracting frictions: the country cannot commit to repay its debts nor to a speci…c path of future debt issues, and contracts cannot be made state contingent nor renegotiated. We show that in order to satisfy incentive compatibility the country must issue shortterm debt, which exposes it to roll-over crises and ine¢ cient repayments. We examine two policies – restructuring and repro…ling –and show that both improve ex ante welfare if structured correctly. Key to the welfare results is the country’s ability to choose its debt structure so as to neutralize any negative e¤ect resulting from the redistribution of payments across creditors in times of crises. Keywords: sovereign debt, dilution, optimal maturity, restructuring, repro…ling, IMF. JEL Classi…cation: F33, F34, F36, F41, G15 Fernández: NYU, NBER, CEPR, IZA, and ESOP. Martin: CREI , Universitat Pompeu Fabra, Barcelona GSE, IMF, and CEPR. We thank seminar participants at the IMF, LACEA, the Sveriges Riksbank, and Olivier Blanchard, Marcus Brunnermeier, Marcos Chamon, Giovanni Dell’Ariccia, Luc Laeven, and Damiano Sandri for very helpful discussions. Fernández acknowledges support from the CV Starr Center and Martin acknowledges support from the Spanish Ministry of Science and Innovation (grant ECO2011-23197), the Generalitat de Catalunya-AGAUR (grant 2014SGR-830), the Barcelona GSE Research Network, the ERC (Consolidator Grant FP7-615651), and the IMF Research Fellowship. This work was undertaken while both authors were visiting the IMF Research Department and we are grateful to its hospitality.