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Sovereign Risk and Strategic Debt
The world economy is engulfed in an economic crisis. In an attempt to avert a repetition of the Great Depression, governments across the globe have borrowed heavily to finance fiscal stimulus packages. Rising debt levels have put the credit ratings of many countries, including those in the developed world, at risk. A lower credit rating increases the cost of
borrowing. Whilst it thus decreases leverage in fiscal policy, it also has, as this article will show, a positive side effect: since borrowing is costly, a lower credit rating decreases a government’s incentives to increase the deficit shortly before elections to enhance its electoral stakes (resulting in a so-called political budget cycle). The article employs sovereign risk data from the rating agency Fitch and data on treasury bond yields. The theoretical proposition derives empirical support from 29 countries between the years 1980 and 2008. It makes for good news in the current economic environment.
borrowing. Whilst it thus decreases leverage in fiscal policy, it also has, as this article will show, a positive side effect: since borrowing is costly, a lower credit rating decreases a government’s incentives to increase the deficit shortly before elections to enhance its electoral stakes (resulting in a so-called political budget cycle). The article employs sovereign risk data from the rating agency Fitch and data on treasury bond yields. The theoretical proposition derives empirical support from 29 countries between the years 1980 and 2008. It makes for good news in the current economic environment.