Financial disruption as a cost of sovereign default: a quantitative assessment

Andre Diniz and Bernardo Guimaraes

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: The recent European debt crisis has sparked a heated debate on the merits of fiscal austerity. Since the main objective of the proposed fiscal tightenings is to reduce sovereign default risk, the solution to this debate depends on the costs of a sovereign debt restructuring. One important cost is its negative effect on the banking system. This paper extends an off-the-shelf macroeconomic model with financial frictions in order to quantitatively assess the costs of financial disruption ensuing from a sovereign debt restructuring. Results show that the losses from financial disruption are offset by the benefits of a less contractionary fiscal policy. Government size is crucial for the relative effects of financial disruption as austerity becomes substantially more costly when tax rates are large. Keywords: Financial disruption; sovereign debt; sovereign default; Deleveraging.

Keywords: Financial disruption; sovereign debt; sovereign default; Deleveraging. (search for similar items in EconPapers)
JEL-codes: E32 F34 H63 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2014-08
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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http://eprints.lse.ac.uk/86329/ Open access version. (application/pdf)

Related works:
Working Paper: Financial Disruption as a Cost of Sovereign Default: a quantative assessment (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:86329

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