By the same authors

Sovereign Debt: Election Concerns and the Democratic Disadvantage

Research output: Working paperDiscussion paper

Author(s)

Department/unit(s)

Publication details

DatePublished - 2016
PublisherCentre for Competitive Advantage in the Global Economy
Number of pages33
Original languageEnglish

Publication series

NameWorking Paper Series
PublisherCentre for Competitive Advantage in the Global Economy, University of Warwick
No.308
VolumeNov 2016

Abstract

We examine default decisions under different political systems. If democratically elected politicians are unable to make credible commitments to repay externally held debt, default rates are inefficiently high because politicians internalize voter utility loss from repayment. A politician who is motivated by election concerns is more likely to default in order to avoid voter utility losses, and, since lenders recognize this, interest rates and risk premia rise. Therefore, democracy potentially confers a credit market disadvantage. Institutions that are
shielded from political competition, such as independent central banks, may ameliorate the disadvantage by adopting a more farsighted perspective, taking into account how interest rates respond to default risk. Using a numerical measure of institutional farsightedness obtained from the Government Insight Business Risk and Conditions database, we find that the observed relationship between credit-ratings and democratic status is indeed strongly conditional on farsightedness. With myopic institutions, democracy is estimated to cost on
average about 2.5 investment grades. With farsighted institutions there is, if anything, a democratic advantage.

    Research areas

  • Sovereign debt, Default, Risk premia, Autocracy, Democracy, Institutions

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