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Financial disruption as a cost of sovereign default: a quantitative assessment

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  • Diniz, Andre
  • Guimaraes, Bernardo

Abstract

The recent European debt crisis has sparked a heated debate on the merits of fiscal austerity. Since the main objective of the proposed fiscal tightenings is to reduce sovereign default risk, the solution to this debate depends on the costs of a sovereign debt restructuring. One important cost is its negative effect on the banking system. This paper extends an off-the-shelf macroeconomic model with financial frictions in order to quantitatively assess the costs of financial disruption ensuing from a sovereign debt restructuring. Results show that the losses from financial disruption are offset by the benefits of a less contractionary fiscal policy. Government size is crucial for the relative effects of financial disruption as austerity becomes substantially more costly when tax rates are large. Keywords: Financial disruption; sovereign debt; sovereign default; Deleveraging.

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  • Diniz, Andre & Guimaraes, Bernardo, 2014. "Financial disruption as a cost of sovereign default: a quantitative assessment," LSE Research Online Documents on Economics 86329, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:86329
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    More about this item

    Keywords

    Financial disruption; sovereign debt; sovereign default; Deleveraging.;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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