Political Economics of External Sovereign Defaults

Carolina Achury, Christos Koulovatianos and John Tsoukalas
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Carolina Achury: Exeter School of Business, University of Exeter

DEM Discussion Paper Series from Department of Economics at the University of Luxembourg

Abstract: We study how excessive debt-GDP ratios affect political sustainability of prudent fiscal policy in country members of a monetary union. We develop a model with free choice of distinct rent-seeking groups to cooperate (or not) in providing public goods, in seeking rents, and in austere debt issuing through international markets. Noncooperation of rent-seeking groups on fiscal prudence triggers collective fiscal impatience: fiscal debt is issued excessively because each group expropriates extra rents before other groups do so, too. Such collective fiscal impatience leads to a vicious circle of high international interest rates and external-debt default. Our calibration suggests that debt-GDP ratios below 137% foster cooperation among rent-seeking groups, which avoids collective fiscal impatience and default. Our analysis helps in understanding the politicoeconomic sustainability of sovereign rescue packages, emphasizing the need for fiscal targets and for possible debt haircuts.

Keywords: sovereign debt; rent seeking; world interest rates; international lending; incentive compatibility; tragedy of the commons; EU crisis (search for similar items in EconPapers)
JEL-codes: D72 E43 E44 F34 F36 H63 (search for similar items in EconPapers)
Date: 2013
New Economics Papers: this item is included in nep-cdm, nep-mac, nep-opm and nep-pol
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Related works:
Working Paper: Political economics of external sovereign defaults (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:luc:wpaper:13-23

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