Essays on International Private Debt

University of Minnesota Ph.D. dissertation. May 2021. Major: Economics. Advisors: Manuel Amador, Timothy Kehoe. 1 computer file (PDF); viii, 154 pages.This dissertation consists of three chapters. A unifying theme across all chapters is the interaction between international private debt and government's policies. The first chapter argues that excessive international private debt increases the frequency and severity of sovereign debt crises. I develop a quantitative theory of private and public debt that allows me to measure the level of private overborrowing and its effect on the interest rate spread on public debt. In an environment where private credit is constrained by the market value of income, individually optimal private borrowing decisions are inefficient at the aggregate level. High private debt increases the probability of a financial crisis, characterized by a large deleveraging in private debt and a contraction in consumption. During such crises, the drop in consumption is amplified trough the endogenous decline in the market value of collateral. To counter this reduction, the government responds with fiscal bailouts financed with risky external public debt. This response may cause a sovereign debt crisis, which is characterized by high interest rates spreads, and in some cases, default. I find that the theory is quantitatively consistent with the evolution of international private debt, international public debt, and sovereign spreads in Spain from 1999 to 2015. I estimate that excessive private debt raised the interest rate spread on public bonds by at least 3.8 percentage points at its peak in 2012. The second chapter, in turn, proposes a theory of foreign reserves as macroprudential policy. This Chapter was written in collaboration with Julien Bengui and Javier Bianchi. We study an open economy model of financial crises, in which pecuniary externalities lead to overborrowing, and show that by accumulating international reserves, the government can achieve the constrained-efficient allocation. The optimal reserve accumulation policy leans against the wind and significantly reduces the exposure to financial crises. The theory can explain the empirical patterns of public and private international capital flows, both in the cross-section and over time. The third chapter examines the interaction between international debt and inequality. This chapter was written in collaboration with Monica Tran-Xuan. We introduce household heterogeneity in a standard model of sudden stop crises. We find that although there is overborrowing at the aggregate level this result is not true for all types of households. While high income households overborrow, low income households underborrow. In future versions of this paper we would like to study the implications of this result for the redistributional consequences of macroprudential policies