Globalization and Bubbly Government Debt

Abstract

This study develops a model examining government debt bubbles (r < g) in an open economy. The model features financially constrained risk-sharing markets where government debt acts as collateral. Countries differ in their levels of financial development, reflected in the varying degrees of pledgeability of their government debt. We show that government debt bubbles emerge in the group of financially developed countries, stimulating investment and consumption in these countries by redistributing funds from less developed countries. Furthermore, the ability to roll over debt indefinitely allows countries to shift fiscal costs abroad without affecting domestic consumption. The strength of this capability increases with an increasing public debt price.

Keywords: Public Debt, Debt Sustainability, Low Interest Rates, Asset Bubbles, Fiscal Policy

JEL Classification: E62, H62, H63