Refine
Year of publication
- 2015 (1)
Document Type
- Working Paper (1)
Language
- English (1)
Has Fulltext
- yes (1)
Is part of the Bibliography
- no (1)
Keywords
- EU crisis (1)
- Graccident (1)
- Grexit (1)
- incentive compatibility (1)
- international lendin (1)
- rent seeking (1)
- sovereign debt (1)
- tragedy of the commons (1)
- world interest rates (1)
Institute
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.