Working Paper: CEPR ID: DP14961
Authors: Viral Acharya; Raghuram Rajan; Jack B. Shim
Abstract: We examine how a sovereign’s ability to borrow abroad affects the country’s growthand steady state consumption, assuming that the government is both myopic andself-interested. Surprisingly, government myopia can increase a country’s accessto external borrowing. In turn, access to borrowing can extend the government’seffective horizon as the government’s ability to borrow hinges on it convincing creditorsthey will be repaid, which gives it a stake in incentivizing private productionand savings despite its self-interest. In a high-saving country, the lengthening of thegovernment’s effective horizon can incentivize it to tax less, resulting in a “growthboost", with higher steady-state household consumption than if it could not borrow.However, in a country that saves little, the government may engage in more repressivepolicies to enhance its debt capacity and spending. This could lead to a “growthtrap” where household steady-state consumption is lower than if the governmenthad no access to external borrowing. We discuss the effectiveness of alternativedebt policies, including declaring the sovereign’s debt “odious”, debt relief, anddebt ceilings.
Keywords: sovereign debt; government myopia; financial repression; allocation puzzle; debt ceiling
JEL Codes: F3; G28; H2; H3; H6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government myopia (H11) | access to external borrowing (F34) |
| access to external borrowing (F34) | private production and savings (E20) |
| private production and savings (E20) | lower taxation (H29) |
| lower taxation (H29) | economic growth (O49) |
| government borrowing (H74) | tax policy (H20) |
| tax policy (H20) | steady-state outcomes (C62) |
| government borrowing (H74) | household consumption (D10) |
| government borrowing (H74) | economic growth (O49) |
| low-saving countries (E21) | repressive policies (J18) |
| repressive policies (J18) | growth trap (O11) |
| initial endowment and propensity to save (D14) | tax rates (H29) |
| tax rates (H29) | growth boost or growth trap (O40) |