Capacity, Willingness, and Sovereign Default Risk: Reassuring the Market in Times of Crisis

Abstract

Preserving the trust of bond markets is crucial for the world's many indebted countries, but it is still unclear when and how national or international actors can contribute to this goal. We present a set of arguments addressing this question and test them on the case of the eurozone debt crisis. Distinguishing between actors' capacity and willingness to avoid defaults, we argue that the crisis was marked by a lack of capacity at the national level, and limited or uncertain willingness at the European level. Accordingly, we find that European‐level efforts to reassure markets had considerably stronger effects than similar efforts at the national level. Furthermore, national efforts appear to have mattered the least in countries with the least capacity. These findings are based on a comprehensive new dataset of political events and relevant news, and they hold across a number of robustness checks and placebo tests.

The European Semester: Democratic Weaknesses as Limits to Learning

“…Similarly, the European Parliament can only invite the Presidents of the Commission, Council, Eurogroup, and European Council to report to the assembly. This parliamentary passivity may serve the interest of national executives to appease fidgety markets which could overreact to recalcitrant parliaments (Bølstad & Elhardt, ): “increased executive power obtains its legitimacy not from any strong popular backing, but primarily from the economic credibility it claims to generate” (Wilkinson, : 548).…”

Time-Variation in the Pricing of Country Fundamentals in Sovereign Credit Spreads

“…This is more general compared to the extant quantitative literature, which mainly calibrates its parameters to the experience of Argentina. Argentine data Closest to the line of thought in my model is a recent paper by Bølstad and Elhardt (2017). may successfully represent several Latin American experiences, but it is significantly different from many other countries, especially middle-income emerging markets and developed countries where defaults are rare.…”

“…without social unrest. They may become important in a debt trap scenario: the case when the debt ratio reaches a critical level where the process for the debt ratio turns explosive, in which case default is unavoidable Bølstad and Elhardt, 2017).…”

“…24 Several papers discuss the implication of the monetary union (and hence the lack of central bank lendingof-last-resort) as a factor, which could have contributed to multiple equilibria and self-fulfilling features (e.g. De Grauwe and Ji, 2013;Bølstad and Elhardt, 2017). 25 For instance popular opinion on lending to Greece in core countries have been external factors in many respects (though partly Greek government actions determined these).…”

“…Political uncertainty and fundamentals related to debt sustainability aspects (as well as external factors) may also determine probabilities/outcomes of whether a good or bad funding Calvo and Mendoza (1996), CK: Cole and Kehoe (1996), Kru: Krugman (1985), STV: Sachs, Tornell and Velasco (1996), BE: Bølstad and Elhardt (2017), DJ: De Grauwe and Ji (2013), Sachs: Sachs (1983), Pas: Paserman (2017), DMP: Dailami, Masson and Padou (2008), RY: González-Rozada and Yeyati (2008), HN: Hilscher and Nosbusch (2010), CKMM: Corsetti, Pericoli and Sbracia (2005), GPT: Giordano, Pericoli and Tommasino (2013).…”