December 2, 2010

Bad News Spreads

When government debt is downgraded, the ill effects can be felt across countries and financial markets

THE recent European sovereign debt crisis was concentrated in a few countries, but its effects were felt in financial markets throughout the euro area. Following downgrades of credit ratings for countries such as Greece, Ireland, Portugal, and Spain, sovereign bond spreads widened, the costs of insuring sovereign debt (as measured by credit default swap—CDS—spreads) rose, and stock markets well beyond the affected countries felt the pressure (see chart).

The resulting debate over the role of credit rating agencies during crises and the interdependence of different financial markets has focused on changes in sovereign debt ratings. These measure the likelihood that a government will fail to meet its financial obligations and whether these changes have spillover effects across countries and markets in a highly integrated environment, such as the euro area, which includes 16 European economies.

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June 5, 2010

Debt and Democracy

Democracies use windfalls from international commodity price booms to reduce external debt. Autocracies tend to spend them

COMMODITY-exporting countries often experience large commodity price shocks that pose serious challenges to their macroeconomic stability. For example, the sudden influx of foreign earnings from a surge in commodity prices can increase a country’s real exchange rate (the nominal exchange rate, adjusted for inflation) and make its noncommodity exports less competitive. The effect of such unanticipated price changes on the competitiveness of commodity exporters has been studied widely by economists.

There are other significant, if less studied, repercussions on commodity-exporting countries from such price shocks, which boost both foreign reserves and government revenue. The way the government uses revenue earned from a commodity price surge has a direct effect on a country’s macroeconomic performance and can be beneficial or harmful.

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