Working Paper: NBER ID: w2767
Authors: Julio J. Rotemberg
Abstract: I develop two models in which debt repurchases by highly indebted sovereign nations are advantageous for all parties. The models are based on the idea that when sovereign debts are large, bargaining costs are large. Creditors spend more resources convincing the debtor that they are tough when they have more at stake. Also, the sanctions which are sometimes triggered when bargaining fails to produce an agreement are larger when debts are larger. For both these reasons buybacks, which reduce the face value of the outstanding debt, can be beneficial. The resulting equilibria are constrained Pareto Optima. But, donors who subsidize buybacks increase overall welfare more than donors who make direct gifts. I also argue that Bulow and Rogoff (1988)'s empirical evidence on buybacks is consistent with my models.
Keywords: sovereign debt; buybacks; bargaining costs; debt crisis
JEL Codes: F34; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| sovereign debt buybacks (H63) | lower bargaining costs (D43) |
| larger debts (H63) | increased bargaining costs (C78) |
| increased bargaining costs (C78) | inefficient negotiations (D61) |
| buybacks (G34) | lower face value of outstanding debt (G32) |
| lower face value of outstanding debt (G32) | lower bargaining costs (D43) |
| larger debts (H63) | inefficient negotiations (D61) |
| buybacks (G34) | constrained Pareto optima (D10) |