Political Economy of Sovereign Debt: A Theory of Cycles of Populism and Austerity / Alessandro Dovis, Mikhail Golosov, Ali Shourideh.

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Dovis, Alessandro

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TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w21948.Publication details: Cambridge, Mass. National Bureau of Economic Research 2016.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: We study optimal fiscal and redistributive policies in an open economy without commitment. Due to its redistributive motives, the government's incentive to default on its external debt is affected by inequality. We show that in equilibrium the economy endogenously fluctuates between two regimes. In the first regime, the government borrows from abroad, spends generously on transfers and keeps the inequality low. In the second regime, it implements austerity-like policies by cutting transfers, reducing foreign debt and increasing the inequality. The equilibrium dynamics resembles the populist cycles documented in many developing countries.

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January 2016.

We study optimal fiscal and redistributive policies in an open economy without commitment. Due to its redistributive motives, the government's incentive to default on its external debt is affected by inequality. We show that in equilibrium the economy endogenously fluctuates between two regimes. In the first regime, the government borrows from abroad, spends generously on transfers and keeps the inequality low. In the second regime, it implements austerity-like policies by cutting transfers, reducing foreign debt and increasing the inequality. The equilibrium dynamics resembles the populist cycles documented in many developing countries.