Transfer-induced debt dynamics in sovereign default

During the 2010s, the Greek sovereign debt crisis necessitated unprecedented EU financial aid accompanied by austerity conditions. Despite reforms to government spending and taxation, limited consolidation of social transfers led to unexpected expansions in transfer payments. This paper constructs a strategic sovereign default model, calibrated to Greek data, to examine the effects of transfer shocks on sovereign debt spreads. Under high financial stress (e.g., the elevated spreads at the onset of the 2010 Economic Adjustment Program), positive transfer shocks exacerbate already excessive absorption and significantly raise spreads. Under milder stress, these shocks initially produce negligible increases in spreads but lead to persistently higher spreads over the longer term. Stricter transfer-side austerity can mitigate crises and may avert default.