Sovereign Default and Liquidity: The Case for a World Safe Asset

François Le Grand (1, 2) , Xavier Ragot (3, 4, 5)

1 EM - emlyon business school
2 ETH Zürich - Eidgenössische Technische Hochschule - Swiss Federal Institute of Technology [Zürich]
3 ECON - Département d'économie (Sciences Po)
4 CNRS - Centre National de la Recherche Scientifique
5 OFCE - Observatoire français des conjonctures économiques (Sciences Po)

This paper presents a positive and normative study of a world financial market when sovereign countries can default on their debt. We construct a tractable model that enables us to study sovereign default in general equilibrium. The amount of safe assets is thus endogenous and determined by international risk-sharing. We characterize the equilibrium structure and we show that the market equilibrium can generate multiple equilibria. In addition, the market equilibrium is not constrained-efficient because countries do not fully internalize the value of their debt being used as liquidity. We prove that a world fund issuing a safe asset increases aggregate welfare. The fund's relationship with the IMF's Special Drawing Rights is discussed.

Keywords: Sovereign Default; Safe Asset; International Liquidity

Domains: Economics and Finance

François Le Grand, Xavier Ragot. Sovereign Default and Liquidity: The Case for a World Safe Asset. Journal of International Economics, 2021, 131, pp.103462. ⟨10.1016/j.jinteco.2021.103462⟩. ⟨hal-03501397⟩