When is Debt Odious? A Theory of Repression and Growth Traps

71 Pages Posted: 10 Apr 2020 Last revised: 21 May 2020

See all articles by Viral V. Acharya

Viral V. Acharya

New York University - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Raghuram G. Rajan

University of Chicago - Booth School of Business; International Monetary Fund (IMF); National Bureau of Economic Research (NBER)

Jack Shim

New York University, Department of Finance, Students

Multiple version iconThere are 4 versions of this paper

Date Written: March 16, 2020

Abstract

How is a developing country affected by its government’s ability to borrow in international markets? We examine the dynamics of a country’s growth, consumption, and sovereign debt, assuming that the government’s objective is to maximize short-term, typically wasteful, expenditures. Sovereign debt can extend the government’s effective horizon; the government’s ability to borrow hinges on its convincing investors they will be repaid, which gives it a stake in the future. The lengthening of the government’s effective horizon can incentivize it to adopt policies that result in higher steady-state household consumption than if it could not borrow. However, access to borrowing does not always improve government behavior. In a developing country that saves little, the government may engage in repressive policies to enhance its debt capacity, which only ensures that successor governments repress as well. This leads to a “growth trap” where household steady-state consumption is lower than if the government had no access to debt. We argue that such a model can explain the well-known negative correlation between a developing economy’s reliance on external financing and its economic growth. We also analyze the effects of instruments such as debt relief, a debt ceiling, and fiscal transfers in helping a developing economy emerge out of a growth trap, even when governed by a myopic, possibly rapacious, government.

Keywords: Sovereign debt, government myopia, financial repression, allocation puzzle, debt ceiling

JEL Classification: F3, G28, H2, H3, H6

Suggested Citation

Acharya, Viral V. and Rajan, Raghuram G. and Shim, Jack, When is Debt Odious? A Theory of Repression and Growth Traps (March 16, 2020). Available at SSRN: https://ssrn.com/abstract=3555496 or http://dx.doi.org/10.2139/ssrn.3555496

Viral V. Acharya (Contact Author)

New York University - Leonard N. Stern School of Business ( email )

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Suite 9-160
New York, NY NY 10012
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

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Belgium

National Bureau of Economic Research (NBER)

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Raghuram G. Rajan

University of Chicago - Booth School of Business ( email )

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773-702-0458 (Fax)

International Monetary Fund (IMF) ( email )

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National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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773-702-9299 (Phone)
773-702-0458 (Fax)

Jack Shim

New York University, Department of Finance, Students ( email )

New York, NY
United States

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