Globalization and International Public Finance

28 Pages Posted: 3 Apr 2000 Last revised: 17 Oct 2010

See all articles by Michael Kremer

Michael Kremer

Harvard University - Department of Economics; Brookings Institution; National Bureau of Economic Research (NBER); Center for Global Development; Harvard University - Harvard Kennedy School (HKS)

Paras Mehta

Massachusetts Institute of Technology (MIT) - Department of Economics

Date Written: March 2000

Abstract

This paper examines the effect of reduced transaction costs in the international trading of assets on the ability of governments to issue debt. We examine a model in which governments care about the welfare of their citizens, and thus are more inclined to default if a large proportion of their debt is held by foreigners. Reductions in transaction costs make it easier for domestic citizens to share risk by selling debt to foreigners. This may increase tendencies for governments to default, and thus raise their cost of credit and reduce welfare. We find that even in the absence of transaction costs, home bias in placement of government debt may persist, because in the presence of default risk the return on government debt is correlated with the tax burden required to pay the debt. Asset inequality may reduce this home bias, and by increasing foreign ownership, increase incentives for default. Finally, if foreign creditors are less risk averse than domestic creditors, there may be one equilibrium in which domestic creditors hold the asset and default risk is low, and another in which foreign creditors hold the asset and default risk is high.

Suggested Citation

Kremer, Michael R. and Mehta, Paras P., Globalization and International Public Finance (March 2000). NBER Working Paper No. w7575. Available at SSRN: https://ssrn.com/abstract=220036

Michael R. Kremer (Contact Author)

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Paras P. Mehta

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