Working Paper: NBER ID: w30296
Authors: Viral V. Acharya; Raghuram Rajan; Jack Shim
Abstract: We examine how a sovereign’s ability to borrow abroad affects the country’s growth and steady state consumption, assuming that the government is both myopic and self-interested. Surprisingly, government myopia can increase a country’s access to external borrowing. In turn, access to borrowing can extend the government’s effective horizon as the government’s ability to borrow hinges on it convincing creditors they will be repaid, which gives it a stake in incentivizing private production and savings despite its self-interest. In a high-saving country, the lengthening of the government’s effective horizon can incentivize it to tax less, resulting in a “growth boost", 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 repressive policies to enhance its debt capacity and spending. This could lead to a “growth trap” where household steady-state consumption is lower than if the government had no access to external borrowing. We discuss the effectiveness of alternative debt policies, including declaring the sovereign’s debt “odious”, debt relief, and debt ceilings.
Keywords: sovereign debt; economic growth; myopic government; self-interested government
JEL Codes: A0; A1; A11; A13; A14; F0; F02; G0; G00; L0; O0; P0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government Myopia (H11) | Increased Access to External Borrowing (F34) |
| Increased Access to External Borrowing (F34) | Greater Incentives for Private Production and Savings (E20) |
| Greater Incentives for Private Production and Savings (E20) | Lower Tax Rates in High-Saving Countries (H21) |
| Lower Tax Rates in High-Saving Countries (H21) | Boosted Growth and Household Consumption (D10) |
| Increased Access to External Borrowing (F34) | Repressive Policies in Low-Saving Countries (E21) |
| Repressive Policies in Low-Saving Countries (E21) | Growth Trap Characterized by Lower Steady-State Consumption (O41) |
| Access to Foreign Borrowing (F34) | Enhanced Growth in Certain Contexts (O49) |
| Access to Sovereign Debt (F34) | Immediate Resources for Government Spending (H59) |
| Self-Interested Nature of Government (H10) | Long-Term Economic Detriment (F69) |