Discussion Paper Series 2019-E-10

Sovereign Default Triggered by Inability to Repay Debt

Michinao Okachi

The Greek sovereign default episode in 2012 was characterized by its high debt-to-GDP ratio and the severe economic contraction following the default. Conventional strategic default models designed to analyze a government's incentive to default often fail to replicate these characteristics. To address this issue, we provide a dynamic stochastic general equilibrium (DSGE) model where a sovereign default is triggered by the government's inability to repay its debt. We show that the inability-to-repay model replicates the empirical features observed in Greece, while the conventional strategic default model calibrated to the Greek economy does not.

Keywords: Sovereign Default; Dynamic Stochastic General Equilibrium; Inability to Repay Debt; Strategic Decision to Default; Fiscal Limit; Laffer Curve

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

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