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Why Does U.S Public Debt Flow to China?

Author

Listed:
  • Xin Tang

    (International Monetary Fund)

  • Marina Azzimonti

    (Stony Brook University)

Abstract

We show that the massive flows of U.S public debt to China can arise as an equilibrium outcome of a model where governments issue debt to help domestic entrepreneurs insure against idiosyncratic investment risks. Precautionary motive of entrepreneurs pushes down equilibrium interest rate. Hence in autarky, the country with lower investment risks (the U.S) has higher interest rate and lower stock of debt. When it integrates with a country with higher investment risks (China), the extra precautionary demand drives the interest rate down further, lowering the borrowing cost. As a result, the U.S issues more debt, and much of these debt flows to China.

Suggested Citation

  • Xin Tang & Marina Azzimonti, 2017. "Why Does U.S Public Debt Flow to China?," 2017 Meeting Papers 805, Society for Economic Dynamics.
  • Handle: RePEc:red:sed017:805
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