Growth, default and political polarization

30 Sep

New study by Caroline Van Rijckeghem, and Beatrice Weder di Mauro says fundamentals are good for democracies but strong growth is pivotal to avoid default:

It well known, growth is critical for avoiding default through its impact on both the size of the deficit and the scaling variable in the debt-to-GDP ratio. The empirical counterpart is that no default on external sovereign debt was ever observed in a democracy with growth over 3.4% provided there was sufficient balance-of-payment liquidity support. The implication for the Eurozone is that to restore safety, higher growth needs to be actively pursued.

Growth also helps prevent political polarisation, and here another result is revealing. Default on external debt did not happen in any democracy in periods of low international interest rates (specifically a US treasury bill rate of less than 5%) when there were sufficient political constraints (as measure by Henisz’ Polcon index)1. Sufficient representation of interests against default (those depending on trade who might face sanctions, those owning government debt or bank stocks which would suffer in case of default, etc.) has ensured that. Growing discontent as the result of austerity may be the most important factor yet in influencing the probability of default.

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