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Public debt repudiation in a monetary union: the role of the geographical allocation of domestic debt

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Author Info

  • Debora Di Gioacchino
  • Sergio Ginebri
  • Laura Sabani

Abstract

This paper proposes a stylized two-period two-country OLG model illustrating the potential role played by the nationality of investors on the incentives for a government to renege on its domestic debt. The two countries belong to a Monetary Union where monetary policy is decided by the Union’s Central Bank, while fiscal policy is set by each national government. In the first period, governments issue debt which is acquired both by resident and non resident families. In the second period, public debt must be paid back. Since debt is issued internally, discriminatory taxation against foreign investors is not available. The government can thus choose to repay the debt by levying a tax on resident families’ labour income, or to repudiate it. The repayment scheme is the outcome of the interaction between the government and interest groups (identified by resident and non resident families) with conflicting preferences about debt redemption. Families exert their influence on government decisions by proposing a contribution function contingent on policy outcomes. The main result produced by our model is that if a sufficient share of debt is owned abroad, then incentives to default on domestic debt increase irrespective of the stock of public debt. The main implication of this result is that for a given level of domestic debt, diversification, increasing the share of domestic debt held by foreigners, raises countries’ default risk. This is of some relevance for the EMU where a progressive greater integration of the market for sovereign issuances has been observed.

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Bibliographic Info

Paper provided by University of Rome La Sapienza, Department of Public Economics in its series Working Papers with number 81.

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Length: 34
Date of creation: Jun 2005
Date of revision:
Handle: RePEc:sap:wpaper:wp81

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Related research

Keywords: Monetary union; Public debt; Government default; Political economy; Common agency.;

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References

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  1. Di Gioacchino, Debora & Ginebri, Sergio & Sabani, Laura, 2000. " Bribery and Public Debt Repudiation," Public Choice, Springer, vol. 105(3-4), pages 303-21, December.
  2. Harms, Philipp, 2002. "Poverty and Political Risk," Review of International Economics, Wiley Blackwell, vol. 10(2), pages 250-62, May.
  3. Lorenzo Codogno & Carlo Favero & Alessandro Missale, 2003. "Yield spreads on EMU government bonds," Economic Policy, CEPR & CES & MSH, vol. 18(37), pages 503-532, October.
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Cited by:
  1. Waldenström, Daniel, 2010. "Why does sovereign risk differ for domestic and external debt? Evidence from Scandinavia, 1938-1948," Journal of International Money and Finance, Elsevier, vol. 29(3), pages 387-402, April.

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