On sovereign debt

Is it good for a developing country to borrow in international markets?

It depends, argue Acharaya et al. in this paper. They develop a model with three agents: a representative household/productive sector, international investors and a myopic government which wants to maximize short-term, self-interested spending. International lenders lend as long as they expect to get their money back with interest. Since there is no uncertainty in the model, in equilibrium there is neither default nor over-lending. They find that:

• For a country with a high propensity to save among the citizenry, access to foreign borrowing can effectively increase the government’s horizon and reduce its oppressive taxation. In turn, lower taxation enhances steady-state consumption relative to autarky, i.e., there is a “growth boost.”
• For a country with low starting endowment and a low propensity to save among the citizenry, the government may set higher-than-autarky tax rates. This could push the country into a lower consumption “growth trap,” precisely because each rapacious government represses in order to enhance its debt issuance. Since this process might continue ad infinitum for the citizens of such countries, sovereign debt is truly odious.

When is Sovereign Debt Odious? A Theory of Government Repression, Growth Traps, and Growth Boosts
Authors: Viral V. Acharya, Raghuram Rajan, Jack Shim
From: New York University, University of Chicago

When advanced economies borrow in international markets

In this paper Aggarwal et al. study the effects of debt-financed fiscal transfers in a general equilibrium, heterogeneous-agent model of the world economy. Their model has three main features:

• Households in response to a fiscal transfer that raises their wealth above target, they try to spend down the additional wealth over time. This leads to large MPCs and a spending down effect, as in the data;
• The model has open economies with substantial home bias in spending, also in line with the data;
• Domestic fiscal policy affects the worldwide demand for goods as well as the world interest rate.

They find that in the long run, increases in government debt anywhere raise the world interest rate and increase private wealth everywhere. In the short run, a country with a larger-than-average fiscal deficit experiences both a large increase in private savings (“excess savings”) and a small but persistent current account deficit (a slow-motion “twin deficit”).

We show that a multi-country HANK open-economy model is consistent with the initial phases of excess savings and twin deficits that followed the Covid epidemic worldwide. Our model suggests that excess savings are here to last, but that they will be held increasingly by the world’s rich, with twin deficits continuing to pool them across countries.

Excess Savings and Twin Deficits: The Transmission of Fiscal Stimulus in Open Economies
Authors: Rishabh Aggarwal, Adrien Auclert, Matthew Rognlie, Ludwig Straub
From: Stanford University, Northwestern University, Harvard University