Location: 360 Heady Hall
Description: Jiaoting Shi (ISU)
"Unemployment and Sovereign Risk"
Abstract: We introduce the Diamond-Mortensen-Pissarides (DMP) labor search framework into an otherwise standard Eaton-Gersovitz (1981) sovereign debt model. The interactions between external debt dynamics, domestic labor market outcomes, and time-consistent fiscal policies are analyzed. The tension between the debt and labor market is realized through the link of the per-period balanced government budget constraint. In a quantitative exercise of calibrating to Argentina economy, we find that the incorporation of the frictional labor market improves the model’s ability to generate empirically realistic debt level and default frequency. The quantitative impact of high unemployment benefit on deterring vacancy creation not only outweighs its consumption smoothing effect, but also increases vulnerability to a sovereign debt crisis. Our model can serve as a framework for analyzing various stabilization and social-insurance policies in the context of sovereign debt crisis once properly extended to a dynamic labor search environment.