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Globalization and International Public Finance

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  • Michael Kremer
  • Paras Mehta

Abstract

This paper examines the effect of reduced transaction costs in the international trading of assets on the ability of governments to issue debt. We examine a model in which governments care about the welfare of their citizens, and thus are more inclined to default if a large proportion of their debt is held by foreigners. Reductions in transaction costs make it easier for domestic citizens to share risk by selling debt to foreigners. This may increase tendencies for governments to default, and thus raise their cost of credit and reduce welfare. We find that even in the absence of transaction costs, home bias in placement of government debt may persist, because in the presence of default risk the return on government debt is correlated with the tax burden required to pay the debt. Asset inequality may reduce this home bias, and by increasing foreign ownership, increase incentives for default. Finally, if foreign creditors are less risk averse than domestic creditors, there may be one equilibrium in which domestic creditors hold the asset and default risk is low, and another in which foreign creditors hold the asset and default risk is high.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7575.

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Date of creation: Mar 2000
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Handle: RePEc:nbr:nberwo:7575

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  1. Martin Feldstein & Charles Horioka, 1979. "Domestic Savings and International Capital Flows," NBER Working Papers 0310, National Bureau of Economic Research, Inc.
  2. Domowitz, Ian & Glen, Jack & Madhavan, Ananth, 1997. " Market Segmentation and Stock Prices: Evidence from an Emerging Market," Journal of Finance, American Finance Association, American Finance Association, vol. 52(3), pages 1059-85, July.
  3. Jeffrey A. Frankel, 1993. "On Exchange Rates," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262061546, December.
  4. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262150476, December.
  5. repec:fth:harver:1463 is not listed on IDEAS
  6. Scott Freeman & Guido Tabellini, 1991. "The Optimality of Nominal Contracts," NBER Technical Working Papers 0110, National Bureau of Economic Research, Inc.
  7. Bohn, Henning, 1990. "Tax Smoothing with Financial Instruments," American Economic Review, American Economic Association, American Economic Association, vol. 80(5), pages 1217-30, December.
  8. Persson, Mats & Persson, Torsten & Svensson, Lars E O, 1987. "Time Consistency of Fiscal and Monetary Policy," Econometrica, Econometric Society, Econometric Society, vol. 55(6), pages 1419-31, November.
  9. Harold L. Cole & Patrick J. Kehoe, 1996. "Reputation spillover across relationships: reviving reputation models of debt," Staff Report, Federal Reserve Bank of Minneapolis 209, Federal Reserve Bank of Minneapolis.
  10. Bohn, Henning, 1991. "Time consistency of monetary policy in the open economy," Journal of International Economics, Elsevier, Elsevier, vol. 30(3-4), pages 249-266, May.
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Cited by:
  1. Fernando Broner & Jaume Ventura, 2010. "Rethinking the effects of financial liberalization," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 1128, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2013.
  2. Dirk Niepelt, 2008. "Debt Maturity without Commitment," Working Papers 08.05, Swiss National Bank, Study Center Gerzensee.
  3. Camille Cornand & Pauline Gandré & Céline Gimet, 2014. "Increase in Home Bias and the Eurozone Sovereign Debt Crisis," Working Papers halshs-01015475, HAL.
  4. Camille Cornand & Pauline Gandré & Céline Gimet, 2014. "Increase in Home Bias and the Eurozone Sovereign Debt Crisis," Working Papers, Groupe d'Analyse et de Théorie Economique (GATE), Centre national de la recherche scientifique (CNRS), Université Lyon 2, Ecole Normale Supérieure 1419, Groupe d'Analyse et de Théorie Economique (GATE), Centre national de la recherche scientifique (CNRS), Université Lyon 2, Ecole Normale Supérieure.
  5. Wolf Wagner, 2007. "International Risk Sharing and Government Moral Hazard," Open Economies Review, Springer, Springer, vol. 18(5), pages 577-598, November.

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