A Political Model Sovereign Debt Repayment
AbstractBulow and Rogoff (1989) show that a country that has access to a sufficiently rich asset market cannot commit to repay its debts and therefore should be unable to borrow. This is because for any debt contract, there exists a time at which the country is made better off by defaulting and replicating the payoffs of the debt contract through savings in the asset market. This paper provides an answer to this paradox based on a political economy model of debt. It shows that the presence of political uncertainty reduces the ability of a country to save, and hence to replicate the original debt contract after default. In a model where different parties alternate in power, an incumbent party with a low probability of remaining in power has a high short-term discount rate and is therefore unwilling to save. The current incumbent party realizes that in the future whoever achieves power will be impatient as well, making the accumulation of assets unsustainable. This time-inconsistency is shown to be equivalent to the problem faced by a hyperbolic consumer. Because of their inability tosave, politicians demand debt ex-post and the desire to borrow again in the future enforces repayment today
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Bibliographic InfoPaper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 762.
Date of creation: 2004
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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
Web page: http://www.EconomicDynamics.org/society.htm
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sovereign debt; political economy;
Find related papers by JEL classification:
- F34 - International Economics - - International Finance - - - International Lending and Debt Problems
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