Sovereign Debt and Economic Growth When Government is Myopic and Self-interested

82 Pages Posted: 11 Aug 2022 Last revised: 18 Aug 2023

See all articles by Viral V. Acharya

Viral V. Acharya

New York University (NYU) - New York University

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

Date Written: August 15, 2023

Abstract

We examine how a sovereign’s ability to borrow abroad affects the country’s growth and steady state consumption, assuming that the government is both myopic and self-interested. Surprisingly, government myopia can increase a country’s access to external borrowing. In turn, access to borrowing can extend the government’s effective horizon as the government’s ability to borrow hinges on it convincing creditors they will be repaid, which gives it a stake in incentivizing private production and savings despite its self-interest. In a high-saving country, the lengthening of the government’s effective horizon can incentivize it to tax less, resulting in a “growth boost”, with higher steady-state household consumption than if it could not borrow. However, in a country that saves little, the government may engage in more repressive policies to enhance its debt capacity and spending. This could lead to a “growth trap” where household steady-state consumption is lower than if the government had no access to external borrowing. We discuss the effectiveness of alternative debt policies, including declaring the sovereign’s debt “odious”, debt relief, and debt ceilings.

JEL Classification: A0, A1, A11, A13, A14, F0, F02, G0, G00, L0, O0, P0

Suggested Citation

Acharya, Viral V. and Rajan, Raghuram G. and Shim, Jack, Sovereign Debt and Economic Growth When Government is Myopic and Self-interested (August 15, 2023). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 106, 2022, Available at SSRN: https://ssrn.com/abstract=4187173 or http://dx.doi.org/10.2139/ssrn.4187173

Viral V. Acharya

New York University (NYU) - New York University ( email )

Raghuram G. Rajan (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-4437 (Phone)
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
United States
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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