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Domestic and External Debt and Default

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  • Dirk Niepelt

    (Study Center Gerzensee; U Bern)

Abstract

We develop a general equilibrium model with defaultable domestic and external debt. Overlapping generations work, consume, accumulate capital and public debt. Successive, democratically elected governments choose taxes, public goods spending, domestic and external debt issuance and repayment. In Markov perfect equilibrium, political distortions inherent in democratic societies strengthen debt capacity; macroeconomic shocks affect the cost of public funds and debt returns; and debt serves intergenerational risk sharing. Default decisions may or may not be correlated across debt tranches. Minimum debt returns raise the cost of public funds ex post and render default on other tranches more likely; ex ante, they increase the revenue from debt sales but crowd out capital. Political and general equilibrium "wedges" undermine the inter-temporal smoothing of the shadow cost of public funds. Under standard functional form assumptions the model is solved in closed form.

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  • Dirk Niepelt, 2016. "Domestic and External Debt and Default," 2016 Meeting Papers 635, Society for Economic Dynamics.
  • Handle: RePEc:red:sed016:635
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    References listed on IDEAS

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    8. Martin Gonzalez-Eiras & Dirk Niepelt, 2015. "Politico-Economic Equivalence," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(4), pages 843-862, October.
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    Cited by:

    1. Marina Azzimonti & Vincenzo Quadrini, 2018. "International Spillovers and Bailouts," NBER Working Papers 25011, National Bureau of Economic Research, Inc.
    2. Paczos, Wojtek & Shakhnov, Kirill, 2022. "Defaulting on Covid debt," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 77(C).
    3. Marina Azzimonti & Vincenzo Quadrini, 2019. "International spillovers and `ex-ante' efficient bailouts," 2019 Meeting Papers 318, Society for Economic Dynamics.

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