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Towards a Political-Economic Theory of Domestic Debt

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  • Allan Drazen

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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Bibliographic Info

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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  1. Bartolini, Leonardo & Drazen, Allan, 1997. "When liberal policies reflect external shocks, what do we learn?," Journal of International Economics, Elsevier, vol. 42(3-4), pages 249-273, May.
  2. Bohn, Henning, 1988. "Why do we have nominal government debt?," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 127-140, January.
  3. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  4. Bruno, Michael & Easterly, William, 1996. "Inflation's Children: Tales of Crises That Beget Reforms," American Economic Review, American Economic Association, vol. 86(2), pages 213-17, May.
  5. Robert J. Barro, 1995. "Optimal Debt Management," NBER Working Papers 5327, National Bureau of Economic Research, Inc.
  6. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
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