[Published version] [PDF]

Abstract: During sovereign debt crises, countries experience persistent economic declines, spiking spreads, and outflows of capital and workers. To account for these salient features, we develop a sovereign default model with migration and capital accumulation. The model has a two-way feedback. Default risk lowers workers’ welfare and induces emigration, which in turn intensifies default risk by lowering tax base and investment. Compared with a no-migration model, our model produces higher default risk, lower investment, and a more profound and prolonged recession. We find that migration accounts for almost all of the lack of recovery in GDP during the recent Spanish debt crisis.

Working Papers

  • Inequality, Taxation, and Sovereign Default Risk

[SSRN] [PDF] [slides] Last update: March 2021

Abstract: Income inequality and worker migration significantly affect sovereign default risk. Governments often impose progressive taxes to reduce inequality, which redistribute income but discourage labor supply and induce emigration. Reduced labor supply and a smaller high-income workforce erode the current and future tax base, reducing the government's ability to repay debt. I develop a sovereign default model with endogenous non-linear taxation and heterogeneous labor to quantify this effect. In the model, the government chooses the optimal combination of taxation and debt, considering its impact on workers' labor and migration decisions. With the estimated model, I find that income inequality and its interactions with migration explain one-third of the average U.S. state government spread.

  • Intangible Investment during Sovereign Debt Crisis: Firm-level Evidence, with Chang Liu


Abstract: This paper measures the cost of sovereign debt crises by focusing on the impact of sovereign risk on firms’ intangible investment and TFP. Using Italian firm-level data, we find that small firms and high-leverage firms significantly reduce their intangible investment during the Italian sovereign debt crisis. High-leverage firms reallocate their resources from intangible capital to tangible capital to offset the tightening of financial conditions because tangible capital can be used as collateral. We analyze these patterns by developing a quantitative model incorporating sovereign default risk, financial intermediations, and firm investment decisions on both tangible and intangible capital. In the model, government default risk deteriorates banks’ balance sheets, disrupting banks’ ability to finance firms. Since firms depend on external funding to cover a fraction of investment, firms – especially small and high-leverage ones – reduce intangible investment, which hurts their future total factor productivity. We estimate the model using Italian data and find that the increase in sovereign risk explains the slow recovery of productivity after the debt crisis through the intangible investment channel.

  • Lumpy Debt, Monetary Policy, and Investment, with Min Fang

[SSRN] [PDF] New version coming soon