Download This PaperPolitical Cost of Default and Business Cycle in Emerging Countries
38 Pages Posted: 15 Dec 2016 Last revised: 24 Apr 2020
Date Written: November 1, 2019
Abstract
Sovereign default models successfully explain business cycle in emerging economies by matching the stylized facts of main economic aggregates in normal and default periods but they usually fail to reproduce both the large levels of debt and spread observed in the data. We introduce political uncertainty in the standard default model of Arellano (2008): the incumbent has an exogenous probability of not being reelected in the next period, but in the cases when she decides to default, there is a larger probability of losing power. After estimation of the relevant parameters by targeting key business cycle moments, the model generates realistic levels of debt to GDP and spread without a ecting the performance on the other business cycle moments. The estimated political cost of default from the model is shown as being consistent with the decline in confidence in the Argentinian government documented around its 2001 default event.
Keywords: Public debt, Political uncertainty, Small open economy, Sovereign default
JEL Classification: F3, F41, D72, P16, E32
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