Essays on sovereign debt and international capital flows

This dissertation is a collection of three essays on public and private borrowing on international capital markets, with a focus on optimal policy for the government and international financial institutions. Chapter 1 focuses on sovereign debt and default. Recent sovereign default episodes have been associated with substantial output costs, and the sovereign should take into account that any default decision may exacerbate such costs. I construct a two-period model where sovereign debt is held by both foreign creditors and domestic residents. Default on foreign lenders benefits domestic consumption, but default on domestic residents generates an output cost that increases with the extent of the default. I present two sets of optimal policy results. Firstly, I characterize the optimal default decision and show that full repudiation of debt is not optimal when domestic output costs are sufficiently high. A corollary is that the sovereign can issue debt even in the absence of reputational mechanisms. Secondly, I show that it is optimal for the government to render the domestic economy vulnerable to the adverse effects of default, in order to raise funds cheaply from abroad. Economic fragility is an optimal response to the lack of commitment of the sovereign. Chapter 2 extends the results to an infinite horizon specification. If the default decision does not lead to reduced capital market access in the future, the results from the two-period model remain valid in the infinite horizon.

Department dc:contributor.department

Massachusetts Institute of Technology. Dept. of Economics.

Grantor dc:publisher

Massachusetts Institute of Technology

Year dc:date.issued

2009

Author dc:creator

• Basu, Suman S. (Suman Sambha)

Advisor dc:contributor.advisor

• Olivier J. Blanchard and Guido Lorenzoni.

• Economics.

Statement dc:rights

• M.I.T. theses are protected by copyright. They may be viewed from this source for any purpose, but reproduction or distribution in any format is prohibited without written permission. See provided URL for inquiries about permission.

Licence dc:rights.uri

• http://dspace.mit.edu/handle/1721.1/7582

Language dc:language.iso

eng

Handle dc:identifier.uri

http://hdl.handle.net/1721.1/49711

OAI identifier oai:identifier

oai:dspace.mit.edu:1721.1/49711