[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] Updated, April 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

[SSRN] [PDF] Updated, July 2021

Abstract: This paper measures the output and TFP costs of sovereign risk by focusing on firm-level investment. Combining Italian firm-level and aggregate-level data, we show that firms reduce their investment and reallocate their resources away from intangible assets and towards tangible assets during the sovereign debt crisis. This asset reallocation is more pronounced among small and high-leverage firms, indicating the role of financial constraints. In our model, sovereign risk deteriorates banks' balance sheets, disrupting banks' ability to finance firms. Firms with greater external financing needs are more exposed to sovereign risk. Facing tightening financial constraints, firms internalize that tangibles can be used as collateral while intangibles can not, thus reallocating resources towards tangible investment. In a counterfactual analysis, we find that elevated sovereign risk explains 86% of output losses and 72% of TFP losses during the 2011-2013 Italian sovereign debt crisis.

  • Debt Heterogeneity and Investment Responses to Monetary Policy, with Min Fang


Abstract: We study how debt heterogeneity determines firm-level investment responses to monetary policy shocks focusing on the role of debt maturity. We first document that debt heterogeneity in both leverage and maturity significantly affects the responses of firm-level investment to monetary policy shocks: firms who hold more debt and/or hold more long-term debt are less responsive to monetary policy shocks. Evidence from credit ratings and borrowing behavior indicates that the higher default risk embedded in long-term debt plays an essential role. We then develop a heterogeneous firm model with investment, long-term and short-term debt, and default risk to quantitatively interpret these facts. In the model, firms with higher leverage and/or more long-term debt are more likely to default on their external debt and consequently face a higher marginal cost of external finance. As a result, these firms are less responsive in terms of investment to expansionary monetary policy shocks. The effect of monetary policy on aggregate investment, therefore, depends on the joint distribution of firms' leverage and maturity.