Debt, Defaults and Dogma: politics and the dynamics of sovereign debt markets

We combine three international datasets containing information on the political leanings of the ruling government, sovereign debt yields, and key macroeconomic quantities. This yields new stylized facts regarding the influence of the political leanings of a country's government on their international borrowing costs as well as on fiscal policy. First, left wing governments, on average, pay 134 basis points more than right wing governments to borrow on international debt markets. Second, interest rates on left-wing government debt are 50 percent more volatile than their right-wing counterparts and 40 percent less negatively correlated with output. Third, government spending is very highly correlated with GDP with left governments showing a lower positive correlation and much less volatility than right wing governments. We proceed to build a sovereign default model in which elections determine which one of two politically heterogeneous policy makers will be in charge of the government. When the two policy makers differ in the marginal impact of their fiscal choices on their re-election probabilities, our model delivers the above-mentioned features of the data. In addition, in keeping with the data, right-wing governments display lower tax rates and government consumption to GDP shares than left-wing governments in our calibrated model. Left governments systematically default at higher income levels than right governments leading to political default events when the left replaces the right as well as higher average borrowing costs for the left government. The model implies that re-election probabilities are increasing in good times. These results are obtained without assuming any differences in the preferences of the two types of policy makers.