Political Economics of External Sovereign Defaults

72 Pages Posted: 17 Jul 2015

See all articles by Carolina Achury

Carolina Achury

University of Exeter Business School

Christos Koulovatianos

Universite du Luxembourg - Faculty of Law, Economics and Finance

John D. Tsoukalas

University of Glasgow - Department of Economics

Date Written: July 2, 2015

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

JEL Classification: H63, F34, F36, G01, E44, E43, D72

Suggested Citation

Achury, Carolina and Koulovatianos, Christos and Tsoukalas, John D., Political Economics of External Sovereign Defaults (July 2, 2015). CFS Working Paper, No. 508. Available at SSRN: https://ssrn.com/abstract=2631418 or http://dx.doi.org/10.2139/ssrn.2631418

Carolina Achury

University of Exeter Business School ( email )

Streatham Court
Xfi Building, Rennes Dr.
Exeter, EX4 4JH
United Kingdom

Christos Koulovatianos (Contact Author)

Universite du Luxembourg - Faculty of Law, Economics and Finance ( email )

162a, avenue de la Faïencerie
Luxembourg-Limpertsberg, L-1511
Luxembourg

John D. Tsoukalas

University of Glasgow - Department of Economics ( email )

Adam Smith Building
Glasgow, Scotland G12 8RT
United Kingdom

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