The COVID-19 epidemic in emerging markets risks a combined health, economic, and debt crisis. We integrate a standard epidemiology model into a sovereign default model and study how default risk impacts the ability of these countries to respond to the epidemic. Lockdown policies are useful for alleviating the health crisis but they carry large economic costs and can generate costly and prolonged debt crises. The possibility of lockdown induced debt crises in turn results in less aggressive lockdowns and a more severe health crisis. We find that the social value of debt relief can be substantial because it can prevent the debt crisis and can save lives.

At least one co-author has disclosed a financial relationship of potential relevance for this research. Further information is available online at http://www.nber.org/papers/w20896.ack NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

This paper develops a New Keynesian model with sovereign debt and default. We focus on domestic interest rules governing monetary policy and external foreign currency government debt that is defaultable. Monetary policy and default risk interact as they both impact domestic consumption and production. We find that default risk generates monetary frictions, which amplify the monetary response to shocks. Large sovereign default risk depresses domestic consumption and production. These monetary frictions in turn discipline sovereign borrowing, resulting in slower debt accumulation and lower spreads. Our framework replicates the positive co-movements of sovereign spreads with domestic nominal rates and inflation, a salient feature of emerging markets data, and can rationalize the experience of Brazil during the 2015 downturn, with high inflation, nominal rates, and sovereign spreads. A counterfactual experiment shows that, by raising the domestic rate, the Brazilian central bank not only reduced inflation but also alleviated the debt crisis. * We thank our discussants Giancarlo Corsetti, Radek Paluszynski, and Vivian Yue for insightful comments and suggestions. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. Contact

Sovereigns resolve their default status by offering bond swaps to their lenders, usually following negotiations. We model this interaction in a quantitative model of borrowing and default, and focus on its consequences for debt levels, default risk, and haircuts. The empirical literature finds that the bulk of debt relief is implemented by lengthening the maturity of debt, rather than changing face value. Countries exit renegotiations with less debt but with a greater share of long-term debt in total, compared to the maturity structure at the time of default. A standard maturity choice model, augmented with a renegotiation phase, is unable to replicate this critical feature of the data. We explain this negative result by showing an equivalence between the choice of maturity during the swap and and at issuance, in key states of the world. Introducing a demand shock solves the puzzle. We interpret this reduced-form shock in the context of the literature on political turnover risk. It captures in a parsimonious way the notion that emerging markets may elect policy-makers more prone to short-termism.

We thank Alexandra Solovyeva for excellent research assistance. We also thank our discussants Nuno Coimbra and Alessandro Dovis for insightful comments and suggestions. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis, the Federal Reserve System, or the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.