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Income Inequality and Sovereign Default

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Abstract

In this paper, we study the role of income inequality in government's borrowing and default decisions. We consider a standard endogenous sovereign debt default model and extend it to allow for heterogeneous agents. In addition to shocks to the average income level, we consider the effect of shocks to income distribution. Consistent with the data, income dispersion across individuals increases during a recession and decreases during an expansion. The model is calibrated to match a number of stylized facts for Argentina. We show that (i) rising income inequality within a country increases the probability of default significantly; (ii) the effect of output shocks is larger than the effect of inequality shocks; (iii) the joint effect of these two shocks can generate a high default probability consistent with the Argentine data; (iv) the model can match the high volatility of consumption of the poor relative to the rich; (v) progressive income taxes can reduce the default risk.

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  • Kiyoung Jeon & Zeynep Yom, 2016. "Income Inequality and Sovereign Default," Villanova School of Business Department of Economics and Statistics Working Paper Series 29, Villanova School of Business Department of Economics and Statistics.
  • Handle: RePEc:vil:papers:29
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    Cited by:

    1. D’Erasmo, P. & Mendoza, E.G. & Zhang, J., 2016. "What is a Sustainable Public Debt?," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 2493-2597, Elsevier.
    2. Kose, Ayhan & Ohnsorge, Franziska & Sugawara, Naotaka, 2020. "Benefits and Costs of Debt: The Dose Makes the Poison," CEPR Discussion Papers 14439, C.E.P.R. Discussion Papers.
    3. Pablo D'Erasmo & Enrique G. Mendoza, 2016. "Distributional Incentives In An Equilibrium Model Of Domestic Sovereign Default," Journal of the European Economic Association, European Economic Association, vol. 14(1), pages 7-44, February.
    4. Farzana Alamgir & Alok Johri, 2022. "International Sovereign Spread Differences and the Poverty of Nations," Department of Economics Working Papers 2022-06, McMaster University.
    5. Antonio Cusato Novelli, 2021. "Sovereign default, political instability and political fragmentation," Review of International Economics, Wiley Blackwell, vol. 29(4), pages 732-755, September.
    6. D’Erasmo, Pablo & Mendoza, Enrique G., 2021. "History remembered: Optimal sovereign default on domestic and external debt," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 969-989.
    7. ANA CECILIA PARADA ROJAS & Humberto Ríos Bolívar & JORGE OMAR RAZO DE ANDA, 2019. "Mining Of Classification Trees To Analyze A Multidimensional Phenomenon," Proceedings of International Academic Conferences 9010809, International Institute of Social and Economic Sciences.
    8. Pablo D'Erasmo & Enrique Mendoza, 2011. "Optimal Domestic (and External) Sovereign Default," PIER Working Paper Archive 16-019, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 04 Aug 2016.
    9. Andreasen, Eugenia & Sandleris, Guido & Van der Ghote, Alejandro, 2019. "The political economy of sovereign defaults," Journal of Monetary Economics, Elsevier, vol. 104(C), pages 23-36.
    10. Omar Osman, 2021. "Income Inequality and Financial Disturbances: Does Income Inequality Engender Financial Crises?," Social Indicators Research: An International and Interdisciplinary Journal for Quality-of-Life Measurement, Springer, vol. 157(2), pages 417-442, September.
    11. ANA CECILIA PARADA ROJAS & Humberto Ríos Bolívar & Jorge Omar Razo De Anda, 2019. "Mining Of Classification Trees To Analyze A Multidimensional Phenomenon," Proceedings of International Academic Conferences 9110842, International Institute of Social and Economic Sciences.

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    More about this item

    Keywords

    Sovereign Debt; Default; Income Inequality; Redistribution;
    All these keywords.

    JEL classification:

    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • D5 - Microeconomics - - General Equilibrium and Disequilibrium

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