Towards a Political-Economic Theory of Domestic Debt

28 Pages Posted: 11 Jun 2000 Last revised: 4 Oct 2010

See all articles by Allan Drazen

Allan Drazen

University of Maryland - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: January 1997

Abstract

A political-economic model of the composition of government debt, that is, whether it is issued to domestic or foreign holders, is presented. The key determinant will be the political constraints on repudiation of foreign and domestic debt, which will determine the nature of the domestic political equilibrium. Economic and political factors determine the effective cost of borrowing at home or abroad, and with the ability to segment markets the government acts like a discriminating monopsonist in placing its debt. A country that expects to face a low effective foreign interest rate, reflecting the expectation that it won't be forced to repay its foreign debts in full, will be characterized by high government spending, a high government budget deficit, low domestic saving and thus a high trade balance deficit so that the domestic economy will look mismanaged in terms of a number of macroeconomic indicators. Very lenient foreign assistance programs would have the same effect.

Suggested Citation

Drazen, Allan, Towards a Political-Economic Theory of Domestic Debt (January 1997). NBER Working Paper No. w5890. Available at SSRN: https://ssrn.com/abstract=225672

Allan Drazen (Contact Author)

University of Maryland - Department of Economics ( email )

College Park, MD 20742-1815
United States
301-405-3477 (Phone)
301-405-7835 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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