December 2012

Banks, Sovereign Debt and the International Transmission of Business Cycles

Luca Guerrieri, Matteo Iacoviello, and Raoul Minetti


This paper studies the international propagation of sovereign debt default. We posit a two-country economy where capital constrained banks grant loans to firms and invest in bonds issued by the domestic and the foreign government. The model economy is calibrated to data from Europe, with the two countries representing the Periphery (Greece, Italy, Portugal and Spain) and the Core, respectively. Large contractionary shocks in the Periphery trigger sovereign default. We find sizable spillover effects of default from Periphery to the Core through a drop in the volume of credit extended by the banking sector.

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Keywords: Sovereign default, spillover effects, DSGE model, banks

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Last Update: July 10, 2020