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Political Economics of External Sovereign Defaults

Author

Listed:
  • Carolina Achury

    (Exeter School of Business, University of Exeter)

  • Christos Koulovatianos

    (CREA, Université du 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.

Suggested Citation

  • Carolina Achury & Christos Koulovatianos & John Tsoukalas, 2013. "Political Economics of External Sovereign Defaults," DEM Discussion Paper Series 13-23, Department of Economics at the University of Luxembourg.
    • Handle: RePEc:luc:wpaper:13-23
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    File URL: https://hdl.handle.net/10993/12220
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    Keywords

    sovereign debt; rent seeking; world interest rates; international lending; incentive compatibility; tragedy of the commons; EU crisis;
    All these keywords.

    JEL classification:

    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior

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