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The Employment Cost of Sovereign Default

Neele Balke
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Neele Balke: University of Chicago; IIES

No 1256, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: This paper analyzes the interaction between government default decisions and labor market outcomes in an environment with persistent unemployment and financial frictions. Sovereign risk impairs bank intermediation through balance sheet effects, worsening the conditions for firms to pre-finance wages and vacancies. This generates a new type of endogenous domestic default cost -- the employment cost of default. The persistence of unemployment produces serial defaults and rationalizes high debt-to-GDP ratios. In the dynamic strategic game between the government and the private sector, anticipation effects allow the study of debt crises in addition to outright default episodes. Introducing employment subsidies and bank regulations affect the government's ability to commit to debt repayment.

New Economics Papers: this item is included in nep-dge and nep-gth
Date: 2018
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