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Working Paper
The Politics of Debt in the Era of Rising Rates
We examine how the post-pandemic trajectory of risk-free rates—from historically low levels in 2020 to a steep rise in 2022—affects sovereign debt management and default risk in emerging markets (EMs). Using a dynamic political economy model, we show that weak institutional environments with political incentives to engage in corruption spending lead to over-borrowing and increased default risk, especially during low-rate periods. As rates rise, EMs face high risks of default or the need for austerity programs, depending on the severity of productivity shocks. While International Financial ...