Sovereign Spreads and the Political Leaning of Nations
Using data from 56 nations over 45 years, we find that nations that are more likely to elect left wing governments face higher (and more volatile) sovereign spreads. To explain these facts, we build a sovereign default model in which two policymakers (left and right) alternate in power. The probability of an incumbent staying in power is increasing in the share of government spending. We parametrize the left policymaker as having a higher marginal political gain from increasing government spending than the right does, a feature found in our data. Model economies in which the left is more frequently in power face worse borrowing terms due to higher default risk, a greater reluctance for fiscal austerity in bad times, and a higher share of government spending on average. These features imply large welfare losses for households.
This paper supersedes ‘Debt, Defaults and Dogma: politics and the dynamics of sovereign debt markets.’ For comments and suggestions, we thank Satyajit Chatterjee, Ryan Compton, Pablo D'Erasmo, Pablo Guerron-Quintana (discussant), Illenin Kondo, Guido Lorenzoni, Leonardo Martinez, Luis Schiumerini, and seminar participants at McMaster, Notre Dame, Universidad Nacional de Tucuman, Waterloo, Chicago Fed, Banco Central de Chile, the 2019 CMSG conference, the 2018 SED, the 2018 Midwest Macro Meetings, the 2018 CEA Annual Meetings, the 2018 Tsinghua Workshop in International Finance, and the ADEMU ‘Sovereign Debt in the 21st Century’ Conference. We thank SSHRC, OGS, and the Productivity Partnership (supported by SSHRC) for research funding. Sosa-Padilla is thankful for the hospitality of the Economics departments at Princeton University and the University of Minnesota, where parts of this paper were written. All remaining errors are ours. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.