Labor market distortions under sovereign debt default crises
Tiago Tavares ()
Journal of Economic Dynamics and Control, 2019, vol. 108, issue C
Risk of sovereign debt default has frequently affected both emerging market and developed economies. Such financial crises are often followed by severe declines of employment that are hard to justify using standard economic models. This paper documents that labor market distortions deteriorate substantially around debt default episodes. Two different explanations for such dynamics are evaluated by linking these distortions to changes in labor taxes and costs of financing working capital. When added into a dynamic model of equilibrium default, these features are able to replicate the behavior of the observed labor distortion around a period of financial crisis and can also account for substantial declines of employment. In the model, higher interest rates are propagated into larger costs of hiring labor through the presence of working capital. Then, as an economy is hit with a stream of bad productivity shocks, the incentives to default become stronger, thus increasing the cost of debt. This reduces firm demand for labor and generates a labor wedge. A similar effect is obtained with an endogenously generated counter-cyclical income tax rate policy that also rationalizes why austerity is applied during deep recessions. The model is used to shed light on the recent events of the Euro Area debt crisis, in particular, the Greek sovereign debt default.
Keywords: Sovereign default; Labor markets; Distortionary taxation; Austerity; External debt; Working capital (search for similar items in EconPapers)
JEL-codes: F32 F34 F41 E62 (search for similar items in EconPapers)
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed
Downloads: (external link)
Full text for ScienceDirect subscribers only
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:108:y:2019:i:c:s0165188919301484
Access Statistics for this article
Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok
More articles in Journal of Economic Dynamics and Control from Elsevier
Bibliographic data for series maintained by Haili He ().