Political Economics of Fiscal Consolidations and External Sovereign Accidents

As the recent chain of EU sovereign crises has demonstrated, after an unexpected massive rise to the debt GDP ratio, several EU countries manage to proceed with fiscal consolida- tion quickly and effectively, while other countries, notably Greece, proceed slowly, fuelling “Graccident” and “Grexit” scenarios, even after generous rescue packages, involving debt haircuts and monitoring from official bodies. Here we recursively formulate a game among rent-seeking groups and propose that high debt-GDP ratios lead to predictable miscoordina- tion among rent-seeking groups, unsustainable debt dynamics, and open the path to political accidents that foretell “Graccident” scenarios. Our analysis and application helps in under- standing 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.