Sovereign debt crises and economic reforms have been salient intertwined policy issues throughout the Great Recession, especially in Europe. Economic theory offers two simple policy prescriptions for countries suffering a temporary decline in output. First, they should borrow on international markets to smooth consumption. Second, they should undertake reforms .possibly painful ones in the short run to speed up economic recovery. However, these prescriptions run into difficulties in the presence of limited enforcement issues. On the one hand, risk sharing is hampered by rising default premia. On the other hand, a large outstanding debt can reduce the borrower’s incentive to undertake economic reforms to boost economic growth since some of the gains from growth would accrue to the lenders. To cast light on these trade-offs and to derive positive and normative predictions, this paper proposes a dynamic theory of sovereign debt that rests on four building blocks. The first is that sovereign debt is subject to limited enforcement, and that countries can renege on their obligations subject to real costs. The second building block is that whenever creditors face a credible default threat, they can make a renegotiation offer to the indebted country. This approach conforms with the empirical observations that unordered defaults are rare events, and that there is great heterogeneity in the terms at which debt is renegotiated. The third building block is the possibility for the government of the indebted country to make structural policy reforms that speed up recovery from an existing recession. The fourth building block is that reform effort is not contractible nor can markets commit to punish the past bad behavior of sovereign governments. […]