The Elusive Costs of Sovereign Defaults

Ugo Panizza and Eduardo Levy Yeyati

No 4485, Research Department Publications from Inter-American Development Bank, Research Department

Abstract: Few would dispute that sovereign defaults entail significant economic costs, including, most notably, important output losses. However, most of the evidence supporting this conventional wisdom, based on annual observations, suffers from serious measurement and identification problems. To address these drawbacks, we examine the impact of default on growth by looking at quarterly data for emerging economies. We find that, contrary to what is typically assumed, output contractions precede defaults. Moreover, we find that the trough of the contraction coincides with the quarter of default, and that output starts to grow thereafter, indicating that default episode seems to mark the beginning of the economic recovery rather than a further decline. This suggests that, whatever negative effects a default may have on output, those effects result from anticipation of a default rather than the default itself.

Date: 2006-11
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Related works:
Journal Article: The elusive costs of sovereign defaults (2011)
Working Paper: The Elusive Costs of Sovereign Defaults (2006)
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