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Institutions, Public Debt and Foreign Finance

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  • Nicola Gennaioli
  • Alberto Martin
  • Stefano Rossi

Abstract

We study the role of domestic financial institutions in sustaining capital flows to the private and public sector of a country whose government can default on its debt. As in recent public debt crises, in our model public defaults weaken banks' balance sheets, disrupting domestic financial markets. This effect leads to a novel complementarity between private capital inflows and public borrowing, where the former sustain the latter by boosting the government's cost of default. Our key message is that, by shaping the direction of private capital flows, financial institutions determine whether financial integration improves or reduces government discipline. We explore the implications of this complementarity for financial liberalization and debt-financed bailouts of banks. We present some evidence consistent with complementarity.

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File URL: http://www.carloalberto.org/assets/working-papers/no.124.pdf
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Bibliographic Info

Paper provided by Collegio Carlo Alberto in its series Carlo Alberto Notebooks with number 124.

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Length: 53 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:cca:wpaper:124

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Related research

Keywords: Sovereign Risk; Capital Flows; Institutions; Financial Liberalization; Sudden Stops;

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Cited by:
  1. Lizarazo, Sandra, 2010. "Default Risk and Risk Averse International Investors," MPRA Paper 20794, University Library of Munich, Germany.
  2. Fernando Broner & Jaume Ventura, 2010. "Rethinking the Effects of Financial Liberalization," Working Papers 509, Barcelona Graduate School of Economics.
  3. Aitor Erce, 2012. "Selective sovereign defaults," Globalization and Monetary Policy Institute Working Paper 127, Federal Reserve Bank of Dallas.
  4. Brutti, Filippo, 2011. "Sovereign defaults and liquidity crises," Journal of International Economics, Elsevier, vol. 84(1), pages 65-72, May.
  5. Aitor Erce Domiguez, 2010. "Debtor Discrimination During Sovereign Debt Restructurings," 2010 Meeting Papers 1324, Society for Economic Dynamics.

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