Political economics of external sovereign defaults

Carolina Achury, Christos Koulovatianos and John Tsoukalas

No 508, CFS Working Paper Series from Center for Financial Studies (CFS)

Abstract: We develop a dynamic recursive model where political and economic decisions interact, to study how excessive debt-GDP ratios affect political sustainability of prudent fiscal policies. Rent seeking groups make political decisions - to cooperate (or not) - on the allocation of fiscal budgets (including rents) and issuance of sovereign debt. A classic commons problem triggers collective fiscal impatience and excessive debt issuing, leading to a vicious circle of high borrowing costs and sovereign default. We analytically characterize debt-GDP thresholds that foster cooperation among rent seeking groups and avoid default. Our analysis and application helps in understanding the politico-economic sustainability of sovereign rescues, emphasizing the need for fiscal targets and possible debt haircuts. We provide a calibrated example that quantifies the threshold debt-GDP ratio at 137%, remarkably close to the target set for private sector involvement in the case of Greece.

Keywords: sovereign debt; rent seeking; world interest rates; international lending; incentive compatibility; tragedy of the commons; EU crisis; Grexit; Graccident (search for similar items in EconPapers)
JEL-codes: D72 E43 E44 F34 F36 G01 H63 (search for similar items in EconPapers)
Date: 2015
New Economics Papers: this item is included in nep-mac and nep-pol
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Related works:
Working Paper: Political Economics of External Sovereign Defaults (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:cfswop:508

DOI: 10.2139/ssrn.2631418

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