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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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17542.

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Date of creation: Oct 2011
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Publication status: published as Viral V. Acharya & Raghuram G. Rajan, 2013. "Sovereign Debt, Government Myopia, and the Financial Sector," Review of Financial Studies, Society for Financial Studies, vol. 26(6), pages 1526-1560.
Handle: RePEc:nbr:nberwo:17542

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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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