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External Debt and Political Instability

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  • Sule Ozler
  • Guido Tabellini

Abstract

This paper studies theoretically and empirically the role of domestic political incentives in the accumulation of large external debts by developing countries during 1972-81. The theoretical model characterizes two equilibrium regimes. In one regime the borrower is on its demand curve and changes in the loan size demand are accommodated by the lenders. In the other regime the borrower is credit rationed, and the loan size is determined by the perceived country risk. Higher political instability increases the equilibrium loan size in the first regime and decreases it in the second. Using out-of-sample of evidence, we identify the two regimes in the data. We then find that in the unconstrained regime political instability has a significant positive effect on the loan size, whereas it has no significant effect in the credit rationing regime. Hence the evidence indicates a positive effect of political instability on the demand for sovereign loans, as predicted by the theory.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3772.

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Date of creation: Jul 1991
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Handle: RePEc:nbr:nberwo:3772

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  1. Jeffrey Sachs & Daniel Cohen, 1982. "LDC Borrowing with Default Risk," NBER Working Papers 0925, National Bureau of Economic Research, Inc.
  2. Maurice Obstfeld, 1985. "Capital Mobility in the World Economy: Theory and Measurement," NBER Working Papers 1692, National Bureau of Economic Research, Inc.
  3. Tabellini, Guido & Alesina, Alberto, 1989. "External Debt, Capital Flight and Political Risk," Scholarly Articles 4553019, Harvard University Department of Economics.
  4. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  5. Cukierman, Alex & Edwards, Sebastian & Tabellini, Guido, 1992. "Seigniorage and Political Instability," American Economic Review, American Economic Association, vol. 82(3), pages 537-55, June.
  6. Diwan, Ishac & Verdier, Thierry, 1991. "Distributional aspects of debt adjustment," Policy Research Working Paper Series 657, The World Bank.
  7. Mark Gertler & Kenneth Rogoff, 1989. "Developing country borrowing and domestic wealth," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco.
  8. Hajivassiliou, Vassilis A., 1987. "The external debt repayments problems of LDC's : An econometric model based on panel data," Journal of Econometrics, Elsevier, vol. 36(1-2), pages 205-230.
  9. Jeremy A.Rogoff Bulow & Kenneth, 1986. "A Constant Recontracting Model of Sovereign Debt," University of Chicago - George G. Stigler Center for Study of Economy and State, Chicago - Center for Study of Economy and State 43, Chicago - Center for Study of Economy and State.
  10. Ozler, Sule, 1989. "On the Relation between Reschedulings and Bank Value," American Economic Review, American Economic Association, vol. 79(5), pages 1117-31, December.
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