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Towards a Political-Economic Theory of Domestic Debt


  • Allan Drazen


A political-economic model of the composition of government debt, that is, whether it is issued to domestic or foreign holders, is presented. The key determinant will be the political constraints on repudiation of foreign and domestic debt, which will determine the nature of the domestic political equilibrium. Economic and political factors determine the effective cost of borrowing at home or abroad, and with the ability to segment markets the government acts like a discriminating monopsonist in placing its debt. A country that expects to face a low effective foreign interest rate, reflecting the expectation that it won't be forced to repay its foreign debts in full, will be characterized by high government spending, a high government budget deficit, low domestic saving and thus a high trade balance deficit so that the domestic economy will look mismanaged in terms of a number of macroeconomic indicators. Very lenient foreign assistance programs would have the same effect.

Suggested Citation

  • Allan Drazen, 1997. "Towards a Political-Economic Theory of Domestic Debt," NBER Working Papers 5890, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:5890
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    References listed on IDEAS

    1. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
    2. Bartolini, Leonardo & Drazen, Allan, 1997. "When liberal policies reflect external shocks, what do we learn?," Journal of International Economics, Elsevier, vol. 42(3-4), pages 249-273, May.
    3. Bohn, Henning, 1988. "Why do we have nominal government debt?," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 127-140, January.
    4. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
    5. Bruno, Michael & Easterly, William, 1996. "Inflation's Children: Tales of Crises That Beget Reforms," American Economic Review, American Economic Association, vol. 86(2), pages 213-217, May.
    6. Robert J. Barro, 1995. "Optimal Debt Management," NBER Working Papers 5327, National Bureau of Economic Research, Inc.
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    More about this item

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt


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