Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/113653
Authors: 
Achury, Carolina
Koulovatianos, Christos
Tsoukalas, John
Year of Publication: 
2015
Series/Report no.: 
CFS Working Paper Series 508
Abstract: 
We develop a dynamic recursive model where political and economic decisions interact, to study how excessive debt-GDP ratios affect political sustainability of prudent fiscal policies. Rent seeking groups make political decisions - to cooperate (or not) - on the allocation of fiscal budgets (including rents) and issuance of sovereign debt. A classic commons problem triggers collective fiscal impatience and excessive debt issuing, leading to a vicious circle of high borrowing costs and sovereign default. We analytically characterize debt-GDP thresholds that foster cooperation among rent seeking groups and avoid default. Our analysis and application helps in understanding the politico-economic sustainability of sovereign rescues, emphasizing the need for fiscal targets and possible debt haircuts. We provide a calibrated example that quantifies the threshold debt-GDP ratio at 137%, remarkably close to the target set for private sector involvement in the case of Greece.
Subjects: 
sovereign debt
rent seeking
world interest rates
international lending
incentive compatibility
tragedy of the commons
EU crisis
Grexit
Graccident
JEL: 
H63
F34
F36
G01
E44
E43
D72
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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