Sovereign Spreads and the Political Leaning of Nations

Abstract

Nations with a higher propensity to elect left governments tend to pay higher and more volatile sovereign spreads. We build a sovereign default model with elections between left and right policymakers. Reelection probabilities increase with government spending, with the left having a small advantage (consistent with the data). We use variation in “election efficiency” to create model economies that elect the left more (left leaning) or less frequently (right leaning) in equilibrium. The left-leaning economy has a higher reluctance for fiscal austerity than the right-leaning economy, chooses higher government spending, and faces higher spreads, resulting in lower welfare.