Content uploaded by Alok Johri
Author content
All content in this area was uploaded by Alok Johri on Aug 18, 2022
Content may be subject to copyright.
A preview of the PDF is not available
International Sovereign Spread Differences and the Poverty of Nations *
Preprints and early-stage research may not have been peer reviewed yet.
Abstract and Figures
We find that national poverty head-count ratios and country default risk (measured as sovereign bond spreads) are positively correlated. For example, a nation with 40 percent of the population below the poverty line faces an average spread that is 120 basis points higher than a nation with 10 percent of extremely poor households. This correlation is robust to the inclusion of a number of country specific variables including the country's Gini coefficient and its per capita GDP. We build a sovereign default model that can help explain this correlation that incorporates two types of households-those earning average income and those at the poverty line. The government runs a social safety net which taxes the average income household in order to transfer consumption to the poor. A political constraint that ensures that all households wish to participate in the safety net program constrains the fiscal choices of the government. The novel aspects of the model are calibrated using South African data on household income dynamics, its poverty line and aggregate social transfer rate while the usual calibration targets in the literature are also deployed. A variant of this benchmark economy with a more poor households displays higher default risk than the benchmark economy. The interaction of international borrowing terms with the social safety net and with the political constraint account for this result. Defaults occur when too large a fraction of taxes will be needed for debt repayment and this occurs more often in economies with a larger proportion of the poor. We show that the correlation between the proportion of poor and level of spreads survives even after controlling for the increase in inequality implied by increasing the proportion of poor households. This is achieved by simultaneously increasing the income of the poor. We show that the worse borrowing terms faced by the benchmark economy with higher poverty come with welfare losses due to the lower debt that it can afford and that it would default much less frequently if it faced the same terms as the low-poverty economy. JEL classification: F34, F41, G15, H63.
Figures - uploaded by Alok Johri
Author content
All figure content in this area was uploaded by Alok Johri
Content may be subject to copyright.
ResearchGate has not been able to resolve any citations for this publication.
Emerging market economies typically exhibit a procyclical fiscal policy: public expenditures rise (fall) in economic expansions (recessions), whereas tax rates rise (fall) in bad (good) times. Additionally, the business cycle of these economies is characterized by countercyclical default risk. In this paper we develop a quantitative dynamic stochastic small open economy model with incomplete markets, endogenous fiscal policy and sovereign default where public expenditures and tax rates are optimally procyclical. The model also accounts for the dynamics of other key macroeconomic variables in emerging economies.
A sovereign default model in which the sovereign derives private benefits from public office and contests elections to stay in power is developed. The economy's growth process is modeled as a Markov switching regime, which is shown to be a better description of the data for our set of emerging economies. In the model, consistent with evidence, the sovereign is less likely to be reelected if economic growth is weak. In the low-growth regime, there is higher probability of loss of private benefits due to turnover, which makes the sovereign behave more myopically. This growth-linked variation in effective discount factor is shown to be important in generating volatility in sovereign spreads.
In this paper, we study how income inequality matters for government borrowing and default decisions. We extend a standard endogenous sovereign debt default model to allow for heterogeneous agents and stochastic variability in the dispersion of income. We calibrate the model to match a number of stylized facts for Argentina. We show that (i) rising income inequality within a country increases the probability of default significantly; (ii) the effect of output shocks is larger than the effect of inequality shocks; (iii) the joint effect of these two shocks can generate a high default probability consistent with the Argentine data; (iv) the model can match the high volatility of consumption by the poor relative to the rich; and (v) more progressive income taxes lead to lower default risk.
This study extends the multi-country, politico-economic model of fiscal policy to incorporate wage inequality within each country. In this extended framework, we present conflict over fiscal policy within and across generations and show that a low-inequality country realizes tight fiscal policy with low public debt accumulation, whereas a high-inequality country experiences loose fiscal policy with high public debt. This model prediction is consistent with empirical evidence from OECD countries for the years 1980 to 2010.
Europe's debt crisis resembles historical episodes of outright default on domestic public debt about which little research exists. This paper proposes a theory of domestic sovereign default based on distributional incentives affecting the welfare of risk-averse debt and nondebtholders. A utilitarian government cannot sustain debt if default is costless. If default is costly, debt with default risk is sustainable, and debt falls as the concentration of debt ownership rises. A government favoring bond holders can also sustain debt, with debt rising as ownership becomes more concentrated. These results are robust to adding foreign investors, redistributive taxes, or a second asset.
We develop a closed economy model to study the interactions among sovereign risk premia, fiscal limits, and fiscal policy. The fiscal limits, which measure the government's ability to service its debt, arise endogenously from dynamic Laffer curves. The state-dependent distributions of fiscal limits depend on the growth of lump-sum transfers, the size of the government, the degree of countercyclical policy responses, and economic diversity. The country-specific fiscal limits imply that the market perceives the riskiness of sovereign debt issued by different countries to be different, which is consistent with the observation that developed countries are downgraded at different levels of debt. A nonlinear relationship between sovereign risk premia and the level of government debt emerges in equilibrium, which is in line with the empirical evidence that once risk premia begin to rise, they do so rapidly. Nonlinear simulations show that fiscal austerity measures that aim to balance the government budget in the short run fail to contain the default risk premium, even with sizeable cuts in government purchases; but a long-term plan for fiscal reform, if it credibly changes the market's expectation about future fiscal policies, can alleviate the rising risk premium.