The costs of sovereign default

This paper empirically evaluates four types of costs that may result from an international sovereign default: reputational costs, international trade exclusion costs, costs to the domestic economy through the financial system, and political costs to the authorities. It finds that the economic costs are generally significant but short-lived, and sometimes do not operate through conventional channels. The political consequences of a debt crisis, by contrast, seem to be particularly dire for incumbent governments and finance ministers, broadly in line with what happens in currency crises. [JEL F34, F36, H63, G15] IMF Staff Papers (2009) 56, 683–741. doi:10.1057/imfsp.2009.21 There is broad consensus in the economic literature that the presence ofcostly sovereign defaults is the mechanism that makes sovereign debt possible (Dooley, 2000). In the case of sovereign debt, creditor rights are not as strong as in the case of private debts. If a private firm becomes insolvent, creditors have a well-defined claim on the company’s assets even if they may be insufficient to cover the totality of the debt. These legal rights are Eduardo Borensztein is Regional Economic Advisor for the Southern Cone at th