Do Countries Default in “Bad times”?

Abstract

This paper uses a new dataset to study the relationship between economic output and sovereign default for the period 1820–2004. We find a negative but surprisingly weak relationship between economic output in the borrowing country and default on loans from private foreign creditors. Throughout history, countries have indeed defaulted during bad times (when output was relatively low), but they have also suspended payments when the domestic economy was favorable, and they have maintained debt service in the face of adverse shocks. This constitutes a puzzle for standard theories of international debt, which predict a much tighter negative relationship as default provides partial insurance against declines in output. (JEL: F21, F34, F41)

Coalition Governments and Sovereign Debt Crises

“…I define default as an event when the scheduled debt service is not paid on the due date or the sovereign makes a restructuring offer that contains terms less favorable than the original debt, as opposed to an outright repudiation of debts or a unilateral suspension of payments. This conceptualization is consistent with the technical definition applied by credit‐rating agencies (Beers and Chambers, 2006; Inter‐American Development Bank, 2007) and with existing empirical studies (Kohlscheen, 2006; Kraay and Nehru, 2006; Tomz and Wright, 2007; Van Rijckeghem and Weder, 2006). Thus, my Debt Restructuring variable is defined broadly to include rescheduling or restructuring of debt, including arrears on either principal or interests 5 .…”

Sovereign Debt Restructurings: Preemptive or Post-Default

“…We also provide new evidence on the output costs during sovereign debt crises, which have been studied by Sturzenegger (), Tomz and Wright (), Borensztein and Panizza (), De Paoli et al. (), and Levy‐Yeyati and Panizza ().…”

Financial integration and international risk sharing

“…Cohen (1992) documents an "unexplained" productivity slowdown in the 1980s debt crisis. Tomz and Wright (2007) report that output is below trend by about 1.4% during the entire period of renegotiation for a sample of 175 countries during 1820-2004. Potential channels through which sovereign default causes aggregate output to fall are disruptions to international trade and to the domestic financial system.…”

“…Second, the model predicts that default occurs in bad times when TFP shocks are low. Tomz and Wright (2007) document empirically that default often occurs when countries' output is below the trend. Third, the model predicts that defaulting countries have larger debt than nondefaulting countries.…”