In the book “This Time is Different” by Carmen Reinhart and Ken Rogoff (2009), they have studied a number of different types of financial crisis including:
• Sovereign debt defaults, which occur when a government fails to meet payments on its external and domestic debt obligations, and
• Banking crises, when a country finds that a large part of the banking sector has become insolvent and there is a loss of confidence by the consumer which can often lead to a run on the bank
A high occurrence of global banking crises has historically been linked with a high frequency of sovereign defaults of external debt. The graph below plots the share of countries that have gone through a banking crisis against the comparably calculated share of countries experiencing a default or restructuring in their external debt.
The data suggest that if there is a surge in a banking crisis there is the strong likelihood that this will be accompanied by sovereign debt defaults. Research has shown that real central government debt typically increases by about 86 percent on average (in real terms) during the three years following the crisis. It is therefore hardly surprising that there has been a sharp increase in sovereign defaults in the current global financial environment.
The above is a brief extract from an article published in this month’s econoMAX – click below to subscribe to econoMAX the online magazine of Tutor2u. Each month there are 8 articles of around 600 words on current economic issues.