Person:

Schreger, Jesse

The way in which governments borrow has changed dramatically over the last decade. The first two chapters of this dissertation study the implications of the rise of local currency sovereign borrowing in emerging markets. Chapter 1 presents a method to measure the credit risk on local currency sovereign debt. Chapter 2 argues that private sector balance sheet mismatch explains why nominal sovereign debt risk is not free from default risk. Chapter 3 studies the costs of sovereign default by exploiting the timing of legal rulings in the case of Republic of Argentina v. NML Capital to identify the causal effect of increases in sovereign default risk on firm performance.

Eurozone members are supposedly constrained by the fiscal caps of the Stability and Growth Pact. Yet ever since the birth of the euro, members have postponed painful adjustment. Wishful thinking has played an important role in this failure. We find that governments’ forecasts are biased in the optimistic direction, especially during booms. Eurozone governments are especially over-optimistic when the budget deficit is over the 3 % of GDP ceiling at the time the forecasts are made. Those exceeding this cap systematically but falsely forecast a rapid future improvement. The new fiscal compact among the euro countries is supposed to make budget rules more binding by putting them into laws and constitutions at the national level. But biased forecasts can defeat budget rules. What is the record in Europe with national rules? The bias is less among eurozone countries that have adopted certain rules at the national level, particularly creating an independent fiscal institution that provides independent forecasts.