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A Theory of War Finance

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  • Herschel I. Grossman
  • Taejoon Han

Abstract

This paper analyzes the financial and war-spending policies of a state that faces a war in which defeat would result in the loss of sovereign power and in which the material consequences, conditional on avoiding defeat, are stochastic. The analysis takes explicit account of the historical experiences of lenders, who face debt repudiation if the state to whom they have lent is defeated and who also face partial default if the material consequences of the war are unfavorable for the debtor state, even if it avoids defeat. In this analysis, the state uses war debt to smooth expected consumption intertemporally in response to temporary war spending, and the state also uses contingent debt servicing to insure realized consumption against the risk associated with the material consequences of the war.

Suggested Citation

  • Herschel I. Grossman & Taejoon Han, 1991. "A Theory of War Finance," NBER Working Papers 3799, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:3799 Note: ME
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    References listed on IDEAS

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    1. Grossman, Herschel I & Van Huyck, John B, 1988. "Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation," American Economic Review, American Economic Association, vol. 78(5), pages 1088-1097, December.
    2. Garber, Peter M., 1991. "Alexander Hamilton's market-based debt reduction plan," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 35(1), pages 79-104, January.
    3. Herschel I. Grossman, 1988. "The Political Economy of War Debts and Inflation," NBER Working Papers 2743, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Carlos Pestana Barros & Todd Sandler, 2003. "Internal and external threats: Defence economic analysis," Defence and Peace Economics, Taylor & Francis Journals, vol. 14(6), pages 385-388.
    2. Vincent Medina & Cyr-Denis Nidier, 2003. "Pricing war within a real option framework," Defence and Peace Economics, Taylor & Francis Journals, vol. 14(6), pages 425-435.
    3. Palmer, Carolyn, 2014. "'Flood and fire and famine': Tax policy lessons from the Australian responses to natural disasters," Working Paper Series 3718, Victoria University of Wellington, Chair in Public Finance.

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