Title: Government Reputation and Debt Repayment in Emerging Economies
Abstract: Evidence shows that emerging economies that have repeatedly defaulted on their external obligations are still able to accumulate considerable amounts of debt. On average, an emerging economy defaulted 3 times every 100 years and the ratio of government debt to output is 40%. Existing models of sovereign debt are unable to jointly explain the debt to output ratios and the default frequency in these countries. To resolve this puzzle, I propose a standard small open economy model, with the addition that the government transits through different political states and these transitions cannot be directly observed by lenders. Moreover, after a default, the government and lenders bargain over the recovery rate. I argue that the combination of government reputation with endogenous periods of exclusion and debt renegotiation successfully accounts for the debt to output ratio in emerging economies. The model is consistent with the historical data that defaulting countries return to international loan markets only after settlement with creditors. In this framework, the terms of credit are determined by the lender’s assessment of the government type: the sovereign rating. The model also generates the main empirical regularities of emerging economies. JEL classification: F34, F41.
Publication Year: 2008
Publication Date: 2008-01-01
Language: en
Type: article
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Cited By Count: 49
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