Sovereign Indebtedness, Default, and Gambling for Redemption

23 Pages Posted: 11 May 2010 Last revised: 20 Aug 2010

Date Written: August 18, 2010

Abstract

Developing country politicians, faced with the specter of losing office following a costly default, may be tempted to ‘gamble for redemption’ by instituting policies that increase the volatility of output growth, possibly at the expense of reducing average growth. We present a simple model of debt overhang that captures this intuition. Empirically, we demonstrate that sovereign defaults are significantly associated with an increased probability of job loss by political leaders: after controlling for other determinants, the quantitative effect of a default on the probability of job loss is comparable to a 3.5 standard deviation fall in economic growth. Cross country regressions reveal that, as predicted by our model, higher indebtedness is associated with higher monetary, fiscal, and public investment policy volatility and with policies that increase output volatility at the expense of growth.

Keywords: Debt Forgiveness, Sovereign Default, Public Investment, Gambling for Redemption, Fiscal Policy, Monetary Policy

JEL Classification: F34

Suggested Citation

Malone, Samuel W., Sovereign Indebtedness, Default, and Gambling for Redemption (August 18, 2010). Available at SSRN: https://ssrn.com/abstract=1603728 or http://dx.doi.org/10.2139/ssrn.1603728

Samuel W. Malone (Contact Author)

University of the Andes ( email )

Carrera Primera # 18A-12
DC D.C. 110311
Colombia

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