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What is a default trap?

Default trap

Within the terms of government borrowing, default traps are accredited to the idea that once a country slips into default it will then do so again in the future. This is in comparison to a country with the same future output ability that has never defaulted.

Where have you heard about default traps?

It’s not uncommon or new for countries to default. In the early half of the 1800s the newly established nations of Latin America defaulted periodically as they tried to bolster their economy, and over the last 200 years Portugal, Greece and Spain have all defaulted four or more times.

What you need to know about default traps.

The theory of default traps is related to the idea of asymmetric information between the borrower and the lender and the prospect of the borrower’s future gross domestic product. Once a country has defaulted, it is unlikely that its economy will recover quickly enough to reach the point where it will not need to borrow again within a certain space of time. The initial default weakens the country’s position and as the country is weaker, it's more likely to need more economic assistance in the form of another possible default. Weak revenues, excessive foreign debt and rollover risk are all factors of defaulting.

Find out more about default traps.

If you are interested in default traps, take a look at our page on sovereign borrowing.

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