Why do governments borrow more than is socially desirable?
Governments issue debt for a variety of reasons—both good and bad. Among the good reasons are intertemporal tax-smoothing, fiscal stimulus during economic downturns, and asset management, including providing financial markets with safe assets. While such motives can explain some of the increases in public debt—in particular, after wars or major financial crises—they cannot plausibly account for all of the observed changes. The correlation between public investment and public borrowing—supposedly a major non-wartime motivation for issuing debt—is surprisingly weak. Indeed, the behavior of governments is sometimes quite at odds with these theories. A notable example is the build-up of public debt in many advanced economies during the early 2000s, when the world economy was booming, and the looming prospect of aging-related costs should have spurred public saving.
The Motives to Borrow
Authors: Antonio Fatás, Atish R. Ghosh, Ugo Panizza, Andrea F. Presbitero
From: INSEAD, IMF, The Graduate Institute Geneva
The willingness to pay
First, the decision to default is not driven by solvency conditions but by the strategic considerations of borrowers and lenders. Second, if legal venues cannot be binding, loans to sovereigns can only exist if the borrower suffers from costs in the event of a default. Third, there are many potential costs. Empirically, domestic implications of defaulting and the benefits from an ongoing relationship seem to be the most important factors sustaining sovereign borrowing. Fourth, the evidence is that sanctions and interest rate penalties are rather short lived. Fifth, the possibility to use legal means available to lenders to impose sanctions and recover losses is continuously evolving in favor of lenders.
Public Debt Sustainability
Authors: Xavier Debrun, Jonathan D. Ostry, Tim Willems, Charles Wyplosz
From: IMF, Graduate Institute, Geneva
Debt intolerance
Emerging economies pay high credit spreads on their sovereign debt, despite generally having much lower debt-output ratios than developed countries. This phenomenon, called “debt intolerance”, is not supported by the classic Eaton and Gersovitz (1981) model of sovereign debt. Rebelo and al. argue that what could generate debt intolerance are low levels of financial development defined as a limited ability of countries to hedge shocks to their economies in international capital markets.
Rare Disasters, Financial Development, and Sovereign Debt
Authors: Sergio Rebelo, Neng Wang, Jinqiang Yang
From: Northwestern University, Columbia Business School, Shanghai University of Finance and Economics
