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Sovereigns going bust: Estimating the cost of default

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  • Kuvshinov, Dmitry
  • Zimmermann, Kaspar

Abstract

What is the cost of sovereign default, and what makes default costly? This paper uses a novel econometric method – combining local projections and propensity score weighting as in Jordà and Taylor (2016) – to study these questions. We find that default generates a long-lasting output cost – 2.7% of GDP on impact and 3.7% at peak after five years – but in the longer term, economic activity recovers. The downturn is characterised by a collapse in investment and gross trade. The cost rises dramatically if the default is followed by a systemic banking crisis – peaking at some 9.5% of GDP – but is attenuated for economies with floating exchange rates. Our findings suggest that financial autarky, trade frictions and sovereign-banking spillovers play a key role in generating the cost of default.

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  • Kuvshinov, Dmitry & Zimmermann, Kaspar, 2019. "Sovereigns going bust: Estimating the cost of default," European Economic Review, Elsevier, vol. 119(C), pages 1-21.
    • Handle: RePEc:eee:eecrev:v:119:y:2019:i:c:p:1-21
    DOI: 10.1016/j.euroecorev.2019.04.009
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    More about this item

    Keywords

    Sovereign default; Sovereign debt; Banking crises; Local projections; Inverse propensity score weighting;
    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
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G01 - Financial Economics - - General - - - Financial Crises

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