Sovereign Spreads and the Political Leaning of Nations

Johnny Cotoc, Alok Johri and Cesar Sosa-Padilla

Department of Economics Working Papers from McMaster University

Abstract: Nations vary widely in how often they are governed by left-wing governments. Using data from 56 nations over 45 years, we find that the propensity of a nation to elect the left is positively correlated with both the average level and volatility of their sovereign spreads. To explain these facts, we build a quantitative sovereign default model in which two policymakers (left and right) alternate in power. Reelection probabilities are increasing in government spending, with the left having a small advantage (as found in the data). We use variation in the responsiveness of reelection probabilities to government spending in order to create economies that elect the left more or less frequently in equilibrium. We call these the left leaning and the right leaning economy. The left leaning economy faces worse borrowing terms due to higher default risk. Moreover, both policymakers have a greater reluctance for fiscal austerity and choose a higher share of government spending as compared to their counterparts in the right leaning economy. These features imply large welfare losses for households.

Keywords: Sovereign default; Interest rate spread; Political turnover; Left-wing; Right-wing; Cyclicality of fiscal policy (search for similar items in EconPapers)
JEL-codes: F34 F41 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2023-11
New Economics Papers: this item is included in nep-cdm, nep-dge and nep-opm
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http://socialsciences.mcmaster.ca/econ/rsrch/papers/archive/2023-04.pdf (application/pdf)

Related works:
Working Paper: Sovereign Spreads and the Political Leaning of Nations (2023)
Working Paper: Sovereign Spreads and the Political Leaning of Nations (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:mcm:deptwp:2023-04

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