The Transmission of Quasi-Sovereign Default Risk: Evidence from Puerto Rico (Revised September 2018)
Puerto Rico's unique characteristics as a U.S. territory allow us to examine the transmission of quasi-sovereign default risk to the real economy. We document a negative relationship between increased default probabilities and employment growth in government-demand-dependent industries. The negative relationship strengthens when the government undertakes austerity measures. In addition, fiscal austerity reduces output growth via a local fiscal multiplier effect. Overall, we provide evidence for a novel demand-driven transmission mechanism of sovereign default risk that operates through austerity risk and government demand dependence.
*This paper was previously published under the title "The Costs of (sub)Sovereign Default Risk: Evidence from Puerto Rico."