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Bounding the productivity default shock : Evidence from the The European Sovereign Debt Crisis

Alonso-Ortiz, Jorge and Colla, Esteban and Da-Rocha, Jose-Maria (2015): Bounding the productivity default shock : Evidence from the The European Sovereign Debt Crisis.

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Abstract

We calibrate the cost of sovereign defaults using a continuous time model, where government default decisions may trigger a change in regime of a TFP stochastic 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 drops by 3.70%. This is broadly consistent with the 5% drop that is typically used in the literature. The model is also consistent with observed drops in GDP and observed growth during recovery, predicts reasonable recovery times and illustrates why fiscal multipliers are small in sovereign debt crises. We use these features to argue for the reliability of our calibrated TFP drop.

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