Finance

Sovereignty

Value (mathematics)

Sovereign debt

Politics

Macroeconomics

Labour economics

Machine learning

Debt

Political science

Economics

Wage

Exchange rate

Enforcement

Unemployment

Sovereign default

Stylized fact

Computer science

Monetary economics

Default

Devaluation

American Economic Review

A salient characteristic of sovereign defaults is that they are typically accompanied by large devaluations. This paper presents new evidence of this empirical regularity known as the Twin Ds and proposes a model that rationalizes it as an optimal policy outcome. The model combines limited enforcement of debt contracts and downward nominal wage rigidity. Under optimal policy, default is shown to occur during contractions. The role of default is to free up resources for domestic absorption, and the role of exchange rate devaluation is to lower the real value of wages, thereby reducing involuntary unemployment. (JEL E24, E32, E52, F31, F34, F41)

The Twin Ds: Optimal Default and Devaluation