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Sovereign Borrowing for Dubious Reforms: A model with applications on the EMU

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  • Ludwig , Maximilian

    ()
    (Hamburg University)

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    Abstract

    This paper presents a model where governments need loans to finance reforms and may misuse these funds for consumption without immediately exposing this to its lenders. Such a misuse is ultimately followed by a sovereign default, therefore lenders will try to discipline governments in favor of true reforms. This puts a government and its lenders in a sequential game, which has two remarkable properties: First, discipling a government in favor of reforms may work, albeit far from perfect. Second, the game implies jumps in the interest rate as observed in the EMU debt crisis.

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    File URL: http://siupt.uportu.pt/content/files/dcee/Investigacao/WP_29_2013.pdf
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    Bibliographic Info

    Paper provided by Universidade Portucalense, Centro de Investigação em Gestão e Economia (CIGE) in its series Working Papers with number 29/2013.

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    Length: 33 pages
    Date of creation: 27 May 2013
    Date of revision:
    Handle: RePEc:ris:cigewp:2013_029

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    Postal: Universidade Portucalense – Economics and Management Department (CIGE – Centro de Investigação em Gestão e Economia), Rua Dr. António Bernardino de Almeida, 541-619, 4200 – 072 Porto, Portugal
    Web page: http://www.uportu.pt/site-scripts/centro_pagina.asp?codmenu=71&codcentro=24
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    Related research

    Keywords: Reforms; Sovereign default; Sequential Game; Bail-Out;

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    1. Alberto Alesina & Silvia Ardagna & Vincenzo Galasso, 2011. "The Euro and Structural Reforms," Review of Economics and Institutions, Università di Perugia, vol. 2(1).
    2. Marta Gomez Puig, 2005. "Monetary Integration and the Cost of Borrowing," Working Papers in Economics 134, Universitat de Barcelona. Espai de Recerca en Economia.
    3. G�rard Roland, 2002. "The Political Economy of Transition," Journal of Economic Perspectives, American Economic Association, vol. 16(1), pages 29-50, Winter.
    4. Faruk Balli, 2009. "Spillover effects on government bond yields in euro zone. Does full financial integration exist in European government bond markets?," Journal of Economics and Finance, Springer, vol. 33(4), pages 331-363, October.
    5. Cole, Harold L. & Kehoe, Patrick J., 1995. "The role of institutions in reputation models of sovereign debt," Journal of Monetary Economics, Elsevier, vol. 35(1), pages 45-64, February.
    6. Beetsma, Roel & Giuliodori, Massimo, 2009. "The Macroeconomic Costs and Benefits of the EMU and other Monetary Unions: An Overview of Recent Research," CEPR Discussion Papers 7500, C.E.P.R. Discussion Papers.
    7. Federico Sturzenegger & Jeromin Zettelmeyer, 2007. "Debt Defaults and Lessons from a Decade of Crises," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262195534, December.
    8. Shang-Jin Wei, 1997. "Gradualism versus Big Bang: Speed and Sustainability of Reforms," Canadian Journal of Economics, Canadian Economics Association, vol. 30(4), pages 1234-47, November.
    9. Cole, Harold L & Kehoe, Patrick J, 1998. "Models of Sovereign Debt: Partial versus General Reputations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(1), pages 55-70, February.
    10. Alois Geyer & Stephan Kossmeier & Stefan Pichler, 2004. "Measuring Systematic Risk in EMU Government Yield Spreads," Review of Finance, Springer, vol. 8(2), pages 171-197.
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