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Globalization and International Public Finance

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  • Michael Kremer
  • Paras Mehta

Abstract

This paper examines the effect of reduced transaction costs in the international trading of assets on the ability of governments to issue debt. We examine a model in which governments care about the welfare of their citizens, and thus are more inclined to default if a large proportion of their debt is held by foreigners. Reductions in transaction costs make it easier for domestic citizens to share risk by selling debt to foreigners. This may increase tendencies for governments to default, and thus raise their cost of credit and reduce welfare. We find that even in the absence of transaction costs, home bias in placement of government debt may persist, because in the presence of default risk the return on government debt is correlated with the tax burden required to pay the debt. Asset inequality may reduce this home bias, and by increasing foreign ownership, increase incentives for default. Finally, if foreign creditors are less risk averse than domestic creditors, there may be one equilibrium in which domestic creditors hold the asset and default risk is low, and another in which foreign creditors hold the asset and default risk is high.

Suggested Citation

  • Michael Kremer & Paras Mehta, 2000. "Globalization and International Public Finance," NBER Working Papers 7575, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:7575
    Note: EFG IFM
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    File URL: http://www.nber.org/papers/w7575.pdf
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    References listed on IDEAS

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    1. Persson, Mats & Persson, Torsten & Svensson, Lars E O, 1987. "Time Consistency of Fiscal and Monetary Policy," Econometrica, Econometric Society, vol. 55(6), pages 1419-1431, November.
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    7. Harold L. Cole & Patrick J. Kehoe, 1996. "Reputation spillover across relationships: reviving reputation models of debt," Staff Report 209, Federal Reserve Bank of Minneapolis.
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    9. repec:fth:harver:1463 is not listed on IDEAS
    10. Guido Tabellini & Scott Freeman, 1998. "The optimality of nominal contracts," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 11(3), pages 545-562.
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    Cited by:

    1. Niepelt, Dirk, 2014. "Debt maturity without commitment," Journal of Monetary Economics, Elsevier, vol. 68(S), pages 37-54.
    2. Wolf Wagner, 2007. "International Risk Sharing and Government Moral Hazard," Open Economies Review, Springer, vol. 18(5), pages 577-598, November.
    3. Cornand, Camille & Gandré, Pauline & Gimet, Céline, 2016. "Increase in home bias in the Eurozone debt crisis: The role of domestic shocks," Economic Modelling, Elsevier, vol. 53(C), pages 445-469.
    4. Jaume Ventura & Fernando Broner, 2008. "Rethinking the effects of financial liberalization," 2008 Meeting Papers 747, Society for Economic Dynamics.
    5. Pauline Gandré, 2015. "Domestic creditors as last lenders in debt crises: a simple model with multiple equilibria," Economics Bulletin, AccessEcon, vol. 35(4), pages 2915-2928.
    6. Fernando Broner & Jaume Ventura, 2016. "Rethinking the Effects of Financial Globalization," The Quarterly Journal of Economics, Oxford University Press, vol. 131(3), pages 1497-1542.

    More about this item

    JEL classification:

    • F0 - International Economics - - General
    • F3 - International Economics - - International Finance

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