Working Paper: NBER ID: w2259
Authors: Herschel I. Grossman; John B. Van Huyck
Abstract: This paper analyzes a reputational equilibrium in a model in which nominally denominated sovereign debt serves to shift risk associated with the unpredictability of tax revenues from the sovereign to its lenders. The analysis answers the following set of related questions: Why would a sovereign refrain from inflating when faced with servicing a large quantity of nominal debt? If a sovereign does not plan to use inflation to repudiate its nominal debts, why would it want to issue nominal debt in the first place? What are the distinguishing features of those sovereigns who are willing and able to issue nominal debts?
Keywords: sovereign debt; risk shifting; reputation; inflation
JEL Codes: H63; E42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| unpredictability of tax revenues (H27) | sovereign's decision to issue nominally denominated debt (H63) |
| lenders' expectations regarding inflation (E31) | sovereign's decision to issue nominally denominated debt (H63) |
| sovereign's reputation (H63) | lenders' expectations regarding inflation (E31) |
| unexpected inflation (E31) | negative shocks to aggregate output (Q43) |
| higher inflation expectations (E31) | increased nominal debt issuance (H63) |
| equilibrium amount of nominally denominated debt (H63) | efficient risk shifting (D61) |
| sovereign's survival probability (C41) | equilibrium amount of nominally denominated debt (H63) |
| lenders' memory of past repudiations (G21) | equilibrium amount of nominally denominated debt (H63) |