The productivity cost of sovereign default: evidence from the European debt crisis

Abstract

We calibrate the cost of sovereign defaults using a continuous time model, where government default decisions may trigger a change in the regime of a stochastic TFP process. We calibrate the model to a sample of European countries from 2009 to 2012. By comparing the estimated drift in default relative to that in no-default, we find that TFP falls in the range of 3.70-5.88%. The model is consistent with observed falls in GDP growth rates and subsequent recoveries and illustrates why fiscal multipliers are small during sovereign debt crises