Public debt repudiation: Is it really possible in the EMU? A political economy approach
In cases where policy makers accept "bribes" offered by organised lobbies or interested parties, the government decisions can be modelled as a first price menu auction. In this paper we adapt this structure to model debt repudiation. We consider a one-period model where two generations are present, parents and children, and debt titles are unevenly distributed among parents. The government can repay the debt by a combination of taxes on the children's income and on the outstanding debt. On the hypothesis that all interests are represented (all families are active in the lobbying process), we get the result that, whatever the distribution of the debt, an arbitrarily small repudiation cost excludes the possibility of debt-default. The same result is obtained by introducing a small cost of lobbying. The exclusion of an equilibrium with partial or total debt-default is a relevant result from the standpoint of the stability of the EMU.
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