Working Paper: CEPR ID: DP16166
Authors: Rui Ferreira da Costa Esteves; Jason Lennard; Sean Kenny
Abstract: Default is as old as sovereign debt. Since 1820, sovereigns have spent 18% of time in a state of default. Despite the scale of the problem, the causes and consequences of defaults are still imperfectly understood. In this paper we quantify the aggregate cost of defaults, based on a sample of 50 sovereigns between 1870 and 2010. Since defaults are endogenous to the business cycle, we use the narrative approach to identify plausibly exogenous episodes. We find significant and persistent costs of defaults starting at 1.6% of GDP and peaking at 3.3% before recovering to the pre-crisis level after five years. Moreover, we identify a large heterogeneity of costs by the cause of default. Higher costs are associated with defaults initiated by negative supply shocks, political crises, or adverse terms of trade. In contrast, domestic demand shocks have a moderate effect that is quickly reversed.
Keywords: business cycles; narrative approach; sovereign default
JEL Codes: E32; F34; F41; G01; H63; N10; N20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| sovereign debt crises (F34) | GDP (E20) |
| negative supply shocks (E31) | sovereign defaults (F34) |
| political crises (H12) | sovereign defaults (F34) |
| adverse terms of trade (F14) | sovereign defaults (F34) |
| domestic demand shocks (D12) | sovereign defaults (F34) |
| sovereign defaults (F34) | economic downturns (F44) |