Sovereign default, political instability and political fragmentation

This paper studies sovereign borrowing and default in an economy in which self‐interested political parties bargain over the budget and there is political turnover. The model generates an endogenous distribution of resources that depends on borrowing decisions, and policymakers become short‐sighted. The party in power, as well as the coalition members, obtain a higher share of aggregate consumption as leverage increases. Very small changes in these shares generate non‐negligible shifts in the default/repayment sets. This mechanism provides an explanation for why governments increase their leverage and default more frequently, in comparison to a model with a constant distribution of resources.