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Towards a Political-Economic Theory of Domestic Debt

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Allan Drazen

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Abstract

A political-economic model of the composition of government debt, that is, whether it is issued to domestic or foreign holders, is presented. The key determinant will be the political constraints on repudiation of foreign and domestic debt, which will determine the nature of the domestic political equilibrium. Economic and political factors determine the effective cost of borrowing at home or abroad, and with the ability to segment markets the government acts like a discriminating monopsonist in placing its debt. A country that expects to face a low effective foreign interest rate, reflecting the expectation that it won't be forced to repay its foreign debts in full, will be characterized by high government spending, a high government budget deficit, low domestic saving and thus a high trade balance deficit so that the domestic economy will look mismanaged in terms of a number of macroeconomic indicators. Very lenient foreign assistance programs would have the same effect.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5890.

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Date of creation: Jan 1997
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Handle: RePEc:nbr:nberwo:5890

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Find related papers by JEL classification:
F34 - International Economics - - International Finance - - - International Lending and Debt Problems
H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management

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  1. Michael Bruno & William Easterly, 1996. "Inflation's Children: Tales of Crises that Beget Reforms," NBER Working Papers 5452, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Leonardo Bartolini & Allan Drazen, 1996. "When liberal policies reflect external shocks, what do we learn?," Staff Reports 18, Federal Reserve Bank of New York. [Downloadable!]
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  3. Bohn, Henning, 1988. "Why do we have nominal government debt?," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 127-140, January. [Downloadable!] (restricted)
  4. Robert J. Barro, 1995. "Optimal Debt Management," NBER Working Papers 5327, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Aghion, P. & Bolton, P., 1990. "Government Domestic Debt And The Risk Of Default: A Political-Economic Model Of The Strategic Role Of Debt," DELTA Working Papers 90-11, DELTA (Ecole normale supérieure).
  6. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93. [Downloadable!] (restricted)
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  7. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall. [Downloadable!]
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