Müller, AndreasStoresletten, KjetilZilibotti, Fabrizio2017-03-232017-03-232016-09http://hdl.handle.net/10230/28283We construct a dynamic theory of sovereign debt and structural reforms with three interacting frictions: limited enforcement, limited commitment, and incomplete markets. A sovereign country in recession issues debt to smooth consumption and makes reforms to speed up recovery. The sovereign can renege on debt by suffering a stochastic cost, in which case debt is renegotiated. The competitive Markov equilibrium features large fluctuations in consumption and reform effort. We contrast the equilibrium with an optimal contract with one-sided commitment. A calibrated model can match several salient facts about debt crises. We quantify the welfare effect of relaxing different frictions.application/pdfengThis is an Open Access article distributed under the terms of the Creative Commons Attribution License Creative Commons Attribution 4.0 International, which permits unrestricted use, distribution and reproduction in any medium provided that the original work is properlyattributed.info:eu-repo/semantics/workingPaperAusterityCommitmentDebt overhangDefaultEuropean debt crisisMarkov equilibriumMoral hazardRenegotiationRisk premiaRisk sharingSovereign debtStructural reformsinfo:eu-repo/semantics/openAccess