Debt, Defaults and Dogma: Politics and the Dynamics of Sovereign Debt Markets

Abstract

Using data from 40 nations, we obtain new stylized facts regarding the impact of political leanings of the ruling government on sovereign debt yields and fiscal policy. Left-wing governments' yields are 166 basis points higher and 23% more volatile than yields of right-wing governments. Moreover, left-wing governments face more counter-cyclical yields. Left-wing governments have higher levels of government spending and right-wing governments collect lower tax revenue as a percent of GDP. A calibrated sovereign default model with elections and two politically heterogeneous policy makers who differ in the marginal impact of their fiscal choices on their re-election probabilities delivers the above-mentioned facts.