Wage Rigidity, Working Capital, and the Cost of Sovereign Default

Kiyoung Jeon () and Zeynep Yom
Additional contact information
Kiyoung Jeon: Department of International Trade, Chungnam National University, Daejeon, Korea, https://plus.cnu.ac.kr/html/en/sub02/sub02_020104.html#link

No 68, Villanova School of Business Department of Economics and Statistics Working Paper Series from Villanova School of Business Department of Economics and Statistics

Abstract: Sovereign defaults are labor-market disruptions as much as fiscal events, but standard quantitative default models typically impose their costs as exogenous output losses. Using ninety-two default episodes since 1950, we show that output and consumption fall sharply around default while employment falls less, implying a large deterioration in the labor wedge. We develop a quantitative sovereign-default model in which this cost arises endogenously in the labor market: firms pre-finance wages at a rate linked to sovereign spreads, and an efficiency wage prevents the labor market from clearing, so sovereign risk raises hiring costs and unemployment. Calibrated to Argentina, the model matches average unemployment and the unemployment jump at default, and reproduces the comovement of output, unemployment, and spreads. Counterfactuals show that wage rigidity and sovereign-spread pass-through are central to the employment cost of default. They also reveal that debt capacity and default frequency need not move together: changing labor-market transmission mainly changes how much debt the government can sustain.

Keywords: Sovereign default; Unemployment; Efficiency wages; Working capital; Labor market frictions (search for similar items in EconPapers)
JEL-codes: E24 E32 F34 F41 (search for similar items in EconPapers)
Date: 2026-07
References: Add references at CitEc
Citations:

Downloads: (external link)
http://repec.library.villanova.edu/workingpapers/VSBEcon68.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:vil:papers:68

Access Statistics for this paper

More papers in Villanova School of Business Department of Economics and Statistics Working Paper Series from Villanova School of Business Department of Economics and Statistics Contact information at EDIRC.
Bibliographic data for series maintained by Christopher Kilby ().