Working Paper: CEPR ID: DP9492
Authors: Willem H. Buiter; Ebrahim Rahbari
Abstract: This paper considers the economic and political drivers of sovereign default, focusing on countries rich enough to render sovereign default a ?won?t pay? rather than a ?can?t pay? phenomenon. Unlike many private contracts, sovereign debt contracts rely almost exclusively on self-enforcement rather than on third-party enforcement.Among the social costs of sovereign default are contagion and concentration risk, both within and outside the jurisdiction of the sovereign, and ?rule of law externalities?. We consider illiquidity as a separate trigger for sovereign default and emphasize the role of lenders of last resort for the sovereign.Not only do political economy factors drive sovereign insolvency, they also influence the debt sustainability analyses performed by national and international agencies.We consider it likely that the absence of sovereign defaults in the advanced economies since the (West) German defaults of 1948 and 1953 until the Greek defaults of 2012 was a historical aberration that is unlikely to be a reliable guide to the future.
Keywords: Fiscal sustainability; Intertemporal budget constraint; Political economy; Solvency; Sovereign default; Strategic default
JEL Codes: E62; E63; F34; F41; G01; G18; H26; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| perceived costs of default (G33) | decision to service debt (F34) |
| political economy factors (P19) | perceived costs of default (G33) |
| political economy factors (P19) | decision to service debt (F34) |
| lack of third-party enforcement (P14) | reliance on self-enforcement mechanisms (P14) |
| expectation of future borrowing (G21) | current repayment behavior (G51) |
| systemic externalities (D62) | incentive to avoid default (G33) |
| historical patterns (B15) | future expectations of sovereign behavior (H68) |