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Inflation-default trade-off without a nominal anchor: The case of Greece

Author

Listed:
  • Yasin Kursat Onder

    (Ghent University)

  • Enes Sunel

    (OECD)

Abstract
We investigate the debt sustainability implications of leaving a currency union in the context of the Grexit phenomenon. Using a common currency debt specification that is calibrated to the 2001-2010 episode of the Greek economy, we obtain default in year 2012 as an endogenous outcome in a baseline event analysis. Next, we consider a Grexit scenario in which the government issues both euro and drachma denominated sovereign debt and has the option to inflate away its nominal debt obligations by discretion. In the Grexit economy, lenders charge an ex ante inflation risk premium while buying drachma debt with the anticipation of an ex post inflationary bias. Consequently, in order to obtain drachma debt shares that are representative of the Greek economy in the pre-eurozone episode, we assume that the sovereign now borrows in segmented bond markets and the inflation risk premium on drachma debt is counterbalanced by a risk aversion premium asked by lenders of euro debt. We find that outright default would be avoided in 2012 if drachma was announced as a national currency. However, despite default is avoided, the aversion premium on euro debt shrinks the revenue raised by debt issuance in large amounts and reduces welfare. (Copyright: Elsevier)

Suggested Citation

  • Yasin Kursat Onder & Enes Sunel, 2021. "Inflation-default trade-off without a nominal anchor: The case of Greece," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 39, pages 55-78, January.
    • Handle: RePEc:red:issued:18-220
    DOI: 10.1016/j.red.2020.05.002
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    Cited by:

    1. Kobielarz, M.L., 2023. "Bailout dynamics in a monetary union," Journal of International Economics, Elsevier, vol. 142(C).
    2. Yasin Kür¸sat Önder & Mauricio Villamizar-Villegas & Jose Villegas, 2023. "Debt Moratorium: Theory and Evidence," Borradores de Economia 1253, Banco de la Republica de Colombia.
    3. Yasin Kürsat Önder & Enes Sunel, 2021. "Default of Depreciate," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 21/1023, Ghent University, Faculty of Economics and Business Administration.

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    More about this item

    Keywords

    Leaving currency areas; Discretionary inflation; Currency composition of sovereign debt;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F45 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Macroeconomic Issues of Monetary Unions

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