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Sovereign Debt, Government Myopia, and the Financial Sector

  • Viral V. Acharya
  • Raghuram G. Rajan

What determines the sustainability of sovereign debt? We develop a model where myopic governments seek popularity but can nevertheless commit credibly to service external debt. They do not default when debt is low because they would lose access to debt markets and be forced to reduce spending; they do not default as debt builds up, and net new borrowing becomes difficult, because of the adverse consequences from default to the domestic financial sector. More myopic governments default less often, but tax in a more distortionary way and increase the vulnerability of the domestic financial sector to future government debt default.

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File URL: http://www.nber.org/papers/w17542.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17542.

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Date of creation: Oct 2011
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Publication status: published as Viral V. Acharya & Raghuram G. Rajan, 2013. "Sovereign Debt, Government Myopia, and the Financial Sector," Review of Financial Studies, Society for Financial Studies, vol. 26(6), pages 1526-1560.
Handle: RePEc:nbr:nberwo:17542
Note: CF EFG IFM
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  1. Patrick Bolton & Olivier Jeanne, 2011. "Sovereign Default Risk and Bank Fragility in Financially Integrated Economies," NBER Working Papers 16899, National Bureau of Economic Research, Inc.
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  16. Ozler, Sule, 1993. "Have Commercial Banks Ignored History?," American Economic Review, American Economic Association, vol. 83(3), pages 608-20, June.
  17. Arellano, Cristina, 2008. "Default risk and income fluctuations in emerging economies," MPRA Paper 7867, University Library of Munich, Germany.
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