What is it about?
We build a model where the government faces a two-way choice. Either it services the sovereign debt and receives a stream of tax proceeds, driven by a stochastic process for the total factor productivity (TFP), or it defaults and receives a stream of taxes, but driven by a different process, as default triggers a permanent change in the drift and variance of the TFP. Firms use government decisions to generate beliefs concerning the probability of default. Thus the spot price of an asset reflects the best knowledge about the prospects of the impact of a default on TFP, and the interest rate spread reflects the risk of defaulting on debt.
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Why is it important?
Our model allows the calibration of the cost of sovereign defaults (in terms of total factor productivity falls) for a sample of European countries, 2009 to 2012. We find that TFP falls in the range of 3.70–5.88 %, which is consistent with observed falls in GDP growth rates and subsequent recoveries. Th calibrated model also illustrates why fiscal multipliers are small during sovereign debt crises.
Perspectives
This article involved setting up a theoretical model and determining an empirical strategy to calibrate the model with actual data. By contributing to these steps, I reaffirmed my conviction that both theory and empirical analysis complement each other to expand our knowledge on the forces underlying the evolution of key macroeconomic variables.
Esteban Colla-De-Robertis
Universidad Panamericana
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This page is a summary of: The productivity cost of sovereign default: evidence from the European debt crisis, Economic Theory, December 2015, Springer Science + Business Media,
DOI: 10.1007/s00199-015-0939-y.
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