Commodity Prices and Sovereign Default: A New Perspective on The Harberger-Laursen-Metzler Effect

In this paper we document the stylized facts about the relationship between international oil price swings, sovereign risk and macroeconomic performance of oil-exporting economies. We show that even though being a bigger oil... [ view full abstract ]

In this paper we document the stylized facts about the relationship between international oil price swings, sovereign risk and macroeconomic performance of oil-exporting economies. We show that even though being a bigger oil producer decreases sovereign risk–because it increases a country’s ability to repay–having more oil reserves increases sovereign risk by making autarky more attractive. We then develop a small open economy model of sovereign risk with incomplete international financial markets, in which optimal oil extraction and sovereign default interact. We use the model to understand the mechanisms behind the empirical facts and pay special attention to understanding the macroeconomic effects of the terms-of-trade shocks or what is known in the literature as the Harberger-Laursen-Metzler effect: there is a positive correlation between the terms-of-trade shocks and the trade balance (current account) which declines as shock persistence increases.