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Political Economics of External Sovereign Defaults

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  • Carolina Achury

    (Exeter School of Business, University of Exeter)

  • Christos Koulovatianos

    ()
    (CREA, University of Luxembourg)

  • John Tsoukalas

    (Department of Economics, University of Glasgow)

Abstract

We study how excessive debt-GDP ratios affect political sustainability of prudent fiscal policy in country members of a monetary union. We develop a model with free choice of distinct rent-seeking groups to cooperate (or not) in providing public goods, in seeking rents, and in austere debt issuing through international markets. Noncooperation of rent-seeking groups on fiscal prudence triggers collective fiscal impatience: fiscal debt is issued excessively because each group expropriates extra rents before other groups do so, too. Such collective fiscal impatience leads to a vicious circle of high international interest rates and external-debt default. Our calibration suggests that debt-GDP ratios below 137% foster cooperation among rent-seeking groups, which avoids collective fiscal impatience and default. Our analysis helps in understanding the politicoeconomic sustainability of sovereign rescue packages, emphasizing the need for fiscal targets and for possible debt haircuts.

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Bibliographic Info

Paper provided by Center for Research in Economic Analysis, University of Luxembourg in its series CREA Discussion Paper Series with number 13-23.

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Date of creation: 2013
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Handle: RePEc:luc:wpaper:13-23

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Keywords: sovereign debt; rent seeking; world interest rates; international lending; incentive compatibility; tragedy of the commons; EU crisis;

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