The strongPolitical Economystrong of Sovereign Defaults.pdfVIP

The Political Economy of Sovereign Defaults Eugenia Andreaseny Universidad de Santiago de Chile Guido Sandlerisz Alejandro Van der Ghotex Universidad Torcuato Di Tella Princeton University October 3rd, 2013 Abstract This paper studies how the income distribution and the tax system af- fect sovereign borrowing and default decisions. Does a more regressive tax system or a more unequal income distribution make a government more prone to default? Do they a§ect the amount of sovereign borrowing? We analyze these issues paying special attention to the political constraints faced by governments in raising funds to repay the debt. In doing so, we make progress towards understanding the political economy of sovereign defaults. We perform our analysis by introducing in a standard DSGE model with endogenous sovereign default risk, two novel features: (i) in- come and tax heterogeneity across households; and (ii) a restriction that the government can only access the resources needed to repay the debt if a su¢ cient proportion of the population votes in favor of the proposed Öscal program. We solve our model numerically and Önd that: (i) inequal- ity is bad for sovereign borrowing (i.e.higher income inequality or a more regressive tax system make a government more prone to default); (ii) po- litical constraints may force a government to default even if it is willing to repay; and (iii) political constraints become more relevant when the in- come distribution is more unequal or the tax system more regressive. The second of these Ö