Working Paper: NBER ID: w17542
Authors: Viral V. Acharya; Raghuram G. Rajan
Abstract: What determines the sustainability of sovereign debt? We develop a model where myopic governments seek popularity but can nevertheless commit credibly to service external debt. They do not default when debt is low because they would lose access to debt markets and be forced to reduce spending; they do not default as debt builds up, and net new borrowing becomes difficult, because of the adverse consequences from default to the domestic financial sector. More myopic governments default less often, but tax in a more distortionary way and increase the vulnerability of the domestic financial sector to future government debt default.
Keywords: Sovereign Debt; Government Myopia; Financial Sector
JEL Codes: E62; G2; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government myopia (H11) | reduced likelihood of default (G33) |
| increasing debt (H63) | heightened risks for domestic banks (F65) |
| heightened risks for domestic banks (F65) | discouragement of default (G33) |
| myopic governments (H11) | increase in distortionary taxation (H31) |
| increase in distortionary taxation (H31) | enhanced financial sector's willingness to service debt (G21) |
| myopic governments (H11) | increase vulnerability of financial sector to future defaults (F65) |