Sovereign Debt Ratchets and Welfare Destruction

Peter M. De Marzo, Zhiguo He, Fabrice Tourre

Publikation: Working paperForskningpeer review

Abstrakt

An impatient and risk-neutral government can sell bonds at any time to a more patient group of competitive lenders. The key problem: the government cannot commit to either a particular financing strategy, or a default strategy. Despite risk-neutrality, in equilibrium debt adjusts slowly towards a target debt-to-income level, exacerbating booms and busts. Most strikingly, for any debt maturity structure, the gains from trade are entirely dissipated when trading opportunities are continuous, as lenders compete with each other and the government competes with itself. Moreover, citizens who are more patient than their government are strictly harmed by the unrestricted borrowing. We fully characterize debt dynamics, ergodics, and comparative statics when income follows a geometric Brownian motion, and analyze several commitment devices that allow the sovereign to recapture some gains from trade: self-imposed restrictions on debt issuances and levels, as well as “market-imposed” discipline
OriginalsprogEngelsk
UdgivelsesstedCambridge, MA
UdgiverNational Bureau of Economic Research (NBER)
Antal sider52
DOI
StatusUdgivet - 2021
NavnNational Bureau of Economic Research. Working Paper Series
Nummer28599
ISSN0898-2937

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