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Self-enforcing Debt, Reputation, and the Role of Interest Rates

Martins-da-Rocha, Victor-Filipe; Vailakis, Yiannis (2014), Self-enforcing Debt, Reputation, and the Role of Interest Rates. https://basepub.dauphine.fr/handle/123456789/14502

Type
Document de travail / Working paper
External document link
https://hal.inria.fr/SHS/hal-01097114v1
Date
2014
Publisher
Université Paris-Dauphine
Published in
Paris
Pages
37
Metadata
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Author(s)
Martins-da-Rocha, Victor-Filipe cc

Vailakis, Yiannis
Abstract (EN)
How domestic costs of default do interact with the threat of exclusion from credit markets to determine interest rates and sovereign debt sustainability? In this paper, we address this question in the context of a stochastic general equilibrium model with lack of commitment and self-enforcing debt in which default has two consequences: loss of access to international borrowing and output costs. In contrast to Bulow and Rogoff (1989), we show that part of the ability to borrow is merely attributed to the threat of credit exclusion, or equivalently, to the loss of the sovereign's reputation. Apart from the limit case–analyzed by Hellwig and Lorenzoni (2009)–where output costs are absent, equilibrium interest rates are always higher than growth rates, implying that the way "reputation for repayment" supports debt does not depend on whether debt limits allow agents to exactly roll over existing debt period by period.
Subjects / Keywords
Sovereign Debt; Default; Limited Commitment
JEL
F34 - International Lending and Debt Problems
F3 - International Finance

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