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Sovereign Debt, Government Myopia, and the Financial Sector

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  • Viral V. Acharya
  • Raghuram G. Rajan

Abstract

What determines the sustainability of sovereign debt? We develop a model where myopic governments seek popularity but can nevertheless commit credibly to service external debt. They do not default when debt is low because they would lose access to debt markets and be forced to reduce spending; they do not default as debt builds up and net new borrowing becomes difficult, because of the adverse consequences from default to the domestic financial sector. More myopic governments default less often, but tax in a more distortionary way and increase the vulnerability of the domestic financial sector to future government debt default. The Author 2013. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

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Bibliographic Info

Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

Volume (Year): 26 (2013)
Issue (Month): 6 ()
Pages: 1526-1560

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Handle: RePEc:oup:rfinst:v:26:y:2013:i:6:p:1526-1560

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Cited by:
  1. Viral V. Acharya & Bruce Tuckman, 2013. "Unintended Consequences of LOLR Facilities: The Case of Illiquid Leverage," NBER Working Papers 19773, National Bureau of Economic Research, Inc.

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