Working Paper: NBER ID: w24108
Authors: Anusha Chari; Ryan Leary; Toan Phan
Abstract: Puerto Rico’s unique characteristics as a U.S. territory allow us to examine the channels through which (sub)sovereign default risk can have real effects on the macroeconomy. Post-2012, during the period of increased default probabilities, the cointegrating relationship between real activity in Puerto Rico and the U.S. mainland breaks down and Puerto Rico spirals into a significant decline. We exploit the cross-industry variation in default risk exposure to identify the impact of changes in default risk on employment. The evidence suggests that there are significantly higher employment growth declines in government demand and external finance dependent industries. An additional real effect of default anticipation is that heightened default risk Granger causes Puerto Rico’s austerity measures. An event study analysis using government bond yields and stock returns confirms that news of increased default risk increases the cost of capital for the Puerto Rican government and for publicly traded Puerto Rican firms.
Keywords: subsovereign default risk; Puerto Rico; employment; austerity measures; economic activity
JEL Codes: F3; F4; G15; H2; H3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increased default probabilities (G33) | lower employment growth (J69) |
| austerity measures (E65) | lower employment growth (J69) |
| increased default risk (G33) | declines in employment growth in sensitive industries (O14) |
| negative credit events (G14) | increases in credit spreads (G19) |
| increased default probabilities (G33) | austerity measures (E65) |
| increased default probabilities (G33) | government budget cuts (H60) |