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The Employment Cost of Sovereign Default

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  • Neele Balke

    (University of Chicago; IIES)

Abstract

This paper analyzes the interaction between government default decisions and labor market outcomes in an environment with persistent unemployment and financial frictions. Sovereign risk impairs bank intermediation through balance sheet effects, worsening the conditions for firms to pre-finance wages and vacancies. This generates a new type of endogenous domestic default cost -- the employment cost of default. The persistence of unemployment produces serial defaults and rationalizes high debt-to-GDP ratios. In the dynamic strategic game between the government and the private sector, anticipation effects allow the study of debt crises in addition to outright default episodes. Introducing employment subsidies and bank regulations affect the government's ability to commit to debt repayment.

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  • Neele Balke, 2018. "The Employment Cost of Sovereign Default," 2018 Meeting Papers 1256, Society for Economic Dynamics.
    • Handle: RePEc:red:sed018:1256
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    2. Rojas, Luis E. & Thaler, Dominik, 2023. "The bright side of the doom loop: banks’ sovereign exposure and default incentives," Working Paper Series 2869, European Central Bank.
    3. Tavares, Tiago, 2019. "Labor market distortions under sovereign debt default crises," Journal of Economic Dynamics and Control, Elsevier, vol. 108(C).
    4. Luis Rojas & Dominik Thaler, 2020. "The Bright Side of the Doom Loop: Banks Exposure and Default Incentives," Working Papers 1143, Barcelona School of Economics.

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