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Sovereign indebtedness, default, and gambling for redemption

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  • Samuel W. Malone

Abstract

Developing country politicians, faced with the spectre 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. Copyright 2011 Oxford University Press 2010 All rights reserved, Oxford University Press.

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Bibliographic Info

Article provided by Oxford University Press in its journal Oxford Economic Papers.

Volume (Year): 63 (2011)
Issue (Month): 2 (April)
Pages: 331-354

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Handle: RePEc:oup:oxecpp:v:63:y:2011:i:2:p:331-354

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  1. Presbitero, Andrea F., 2006. "The debt-growth nexus in poor countries: a reassessment," Proceedings of the German Development Economics Conference, Berlin 2006 22, Verein für Socialpolitik, Research Committee Development Economics.
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  5. Jeffrey A. Frankel, 2005. "Contractionary Currency Crashes in Developing Countries," NBER Working Papers 11508, National Bureau of Economic Research, Inc.
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  7. Michael Tomz & Mark L. J. Wright, 2007. "Do countries default in “bad times”?," Working Paper Series 2007-17, Federal Reserve Bank of San Francisco.
  8. Frankel, Jeffrey & Cavallo, Eduardo, 2004. "Does Openness to Trade Make Countries More Vulnerable to Sudden Stops, or Less? Using Gravity to Establish Causality," Working Paper Series rwp04-038, Harvard University, John F. Kennedy School of Government.
  9. Federico Sturzenegger & Jeromin Zettelmeyer, 2007. "Debt Defaults and Lessons from a Decade of Crises," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262195534, January.
  10. Luis Catão & Sandeep Kapur, 2004. "Missing Link: Volatility and the Debt Intolerance Paradox," IMF Working Papers 04/51, International Monetary Fund.
  11. Eduardo Borensztein & Ugo Panizza, 2008. "The Costs of Sovereign Default," IMF Working Papers 08/238, International Monetary Fund.
  12. Megumi Kubota, . "Real Exchange Rate Misalignments: Theoretical Modelling and Empirical Evidence," Discussion Papers 09/24, Department of Economics, University of York.
  13. Emanuel Kohlscheen, 2006. "Sovereign Risk: Constitutions Rule," 2006 Meeting Papers 25, Society for Economic Dynamics.
  14. Tito Cordella & Luca Antonio Ricci & Marta Ruiz-Arranz, 2010. "Debt Overhang or Debt Irrelevance?," IMF Staff Papers, Palgrave Macmillan, vol. 57(1), pages 1-24, April.
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  16. Michael Gavin & Roberto Perotti, 1997. "Fiscal Policy in Latin America," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 11-72 National Bureau of Economic Research, Inc.
  17. Ricardo Hausmann & Dani Rodrik, 2005. "Self-Discovery in a Development Strategy for El Salvador," Journal of LACEA Economia, LACEA - LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION.
  18. Ugo Panizza & Federico Sturzenegger & Jeromin Zettelmeyer, 2009. "The Economics and Law of Sovereign Debt and Default," Journal of Economic Literature, American Economic Association, vol. 47(3), pages 651-98, September.
  19. Tornell, Aaron, 1999. "Voracity and growth in discrete time," Economics Letters, Elsevier, vol. 62(1), pages 139-145, January.
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Citations

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Cited by:
  1. Andrea Filippo Presbitero, 2010. "Total public debt and growth in developing countries," Mo.Fi.R. Working Papers 44, Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences.
  2. Cáceres, Neila & Malone, Samuel W., 2013. "Forecasting leadership transitions around the world," International Journal of Forecasting, Elsevier, vol. 29(4), pages 575-591.

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