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International Financial Integration, Sovereignty, and Constraintson Macroeconomic Policies

  • Kenneth Kletzer

This paper considers the consequences of international financial market integration for national fiscal and monetary policies that derive from the absence of an international sovereign authority to define and enforce contractual obligations across borders. The sovereign immunity of national governments serves as a fundamental constraint on international finance and is used to derive intertemporal budget constraints for sovereign nations and their governments. It is shown that the appropriate debt limit for a country allows for state-contingent repayment. With noncontingent debt instruments, debt renegotiation occurs in equilibrium with positive probability. A model of tax smoothing is adopted to show how information imperfections lead to conventional bond contracts that are renegotiated when a critical level of indebtedness is reached. Renegotiation is interpreted in terms of nominal and real denominated bonds, and implications are drawn about the intertemporal borrowing constraint for monetary policies, the accumulation of reserve assets, and current account sustainability.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 06/79.

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Length: 26
Date of creation: 01 Mar 2006
Date of revision:
Handle: RePEc:imf:imfwpa:06/79
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  8. Kletzer, Kenneth, 2004. "Sovereign Debt, Volatility and Insurance," Santa Cruz Department of Economics, Working Paper Series qt71b785gd, Department of Economics, UC Santa Cruz.
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  14. Thomas, Jonathan & Worrall, Tim, 1990. "Income fluctuation and asymmetric information: An example of a repeated principal-agent problem," Journal of Economic Theory, Elsevier, vol. 51(2), pages 367-390, August.
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  17. 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.
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  19. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
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