Aiyagari, S.R. (1995), “Optimal Capital Income Taxation with Incomplete Markets and Borrowing Constraints,” Journal of Political Economy 103 (6): 1158-1175.
Aiyagari, S.R., A. Marcet, T. Sargent, and J. Seppälä (2002), “Optimal Taxation without State-Contingent Debt,” Journal of Political Economy 110 (6): 1220-1254.
Buiter, W., and J. Eaton (1985), “Policy Decentralization and Exchange Rate Management in Interdependent Economies,” in J.S. Bhandari (ed.), Exchange Rate Management Under Uncertainty (Cambridge, Massachusetts: MIT Press), 31-54.
Calvo, G., and P. Guidotti (1990), “Indexation and Maturity of Government Bonds: An Exploratory Model,” in R. Dornbusch and M. Draghi (eds.), Public Debt Management: Theory and History (Cambridge: Cambridge University Press).
Chari, V.V., L.J. Christiano, and P.J. Kehoe (1994), “Optimal Fiscal Policy in a Business Cycle Model,” Journal of Political Economy 102: 617-652.
Cole, H., and N. Kocherlakota (2001), “Efficient Allocations with Hidden Income and Hidden Storage,” Review of Economic Studies, 68 (3): 523-542
Eaton, J., and M. Gersovitz (1981), “Debt with Potential Repudiation: Theory and Estimation,” Review of Economic Studies 48: 289-309.
Giavazzi, F., and M. Pagano (1990), “Confidence Crises and Public Debt Management,” in R. Dornbusch and M. Draghi (eds.), Public Debt Management: Theory and History (Cambridge: Cambridge University Press).
Grossman, H.I., and J.B. van Huyck (1988). “Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation,” American Economic Review 78: 1088-1097.
Kehoe, P.J., and F. Perri (2002), “International Business Cycles with Endogenous Incomplete Markets,” Econometrica, 70 (3): 907-928.
Kletzer, K.M. (2003), “Sovereign Bond Restructuring: Collective Action Clauses and Official Crisis Intervention,” in Andrew Haldane (ed.), Fixing Financial Crises in the 21st Century (London: Routledge).
Kletzer, K.M. (2004), “Sovereign Debt, Volatility and Insurance,” Eighth Annual Conference of the Central Bank of Chile, August, forthcoming in Journal Economia Chilena.
Kocherlakota, N. R. (1996), “Implications of Efficient Risk Sharing without Commitment,” Review of Economic Studies, 63 (4): 595-609.
Lucas, R.E., and N.L. Stokey (1983), “Optimal Fiscal and Monetary Policy in an Economy without Capital,” Journal of Monetary Economics 12: 55-93.
Persson, T., and L.E.O. Svensson (1984), “Time-Consistent Fiscal Policy and Government Cash-Flow,” Journal of Monetary Economics 14: 365-374.
Thomas, J., and T. Worrall (1990), “Income Fluctuations and Asymmetric Information: An Example of a Repeated Principal-Agent Model,” Journal of Economic Theory 51: 367-90.
Townsend, R.M. (1979), “Optimal Contracts and Competitive Markets with Costly State Verification,” Journal of Economic Theory, 21 (2): 265-93.
The author is Professor of Economics at the University of California, Santa Cruz, and was a visiting scholar at the IMF Institute during summer 2005. This paper was prepared for the 12th International Conference of the Institute for Monetary and Economic Studies at the Bank of Japan, May 30-31, 2005. The author is grateful for support from the Bank of Japan. Several helpful comments and suggestions from Jeromin Zettelmeyer, Jonathan Kearns and other participants at the IMES conference have been incorporated in this version.
For example, Persson and Svensson (1984), Bohn (1988, 1990), Calvo and Guidotti (1990), Giavazzi and Pagano (1990), Chari, Christiano and Kehoe (1994), Missale and Blanchard (1994), Aiyagari and others (2002) and Barro (1999, 2003).
Bohn (1988, 1990) considers why nominal public debt is predominant in light of the conclusions of Lucas and Stokey (1983) and shows that nominal debt indexation is constrained optimal in a model following Barro (1979). Barro (1999, 2003) argues that nominal indexation allows potentially welfare-improving contingent repayment with exogenous stochastic inflation.
The replacement of a tax-smoothing objective for a consumption-smoothing objective for the representative household is demonstrated in Zhu (1992).
For the stochastic gt following a Markov chain (including independently and identically distributed g), this surplus can be written as V (wt, gt). The model extends immediately to the case in which gt follows a Markov chain.
This interpretation of debt renegotiation as the implementation of an implicit contract was suggested by Grossman and van Huyck (1988).
Atkeson (1991) introduces asymmetric information in a repeated moral hazard model of sovereign debt with one-sided commitment. Kletzer (2004) considers bond contracts with no observability of debtor income in a model with two-sided noncommitment.
The time subscripts on the functions reflects dependence on ex ante surplus, Et–1 Vt.
The demonstration that standard debt contracts with bankruptcy are optimal incentive compatible contracts is due to Townsend (1979). In that model and others, debtor income is observable at a cost. Cole and Kocherlakota (2001) implicitly demonstrate bond contracting with no observability in a model with hidden savings and no self-enforcement constraints.
The model implicitly assumes no global constraints, and this first-order condition implies convergence toward a steady state in which taxes are zero and the interest on government credit covers the upper bound for expenditures. With risk-averse counterparts, the steady-state gross interest rate, R, would be smaller than β–1 and the first-order condition would become υ′ (Tt) = RβEtυ′(Tt+1).
and the inequality (21), which holds with equality for EtVt+1 > 0.
Barro (2003) does not model optimal fiscal and monetary policy with nominal debt, but instead argues that nominal debt with independently determined inflation allows state contingency that may be welfare-improving. Bohn (1988, 1990) considers optimal policy without endogenizing debt limits.
Kletzer and Wright (2000) prove that a coalition-proof equilibrium exists. Wright (2001) proves that the result carries over when creditors can commit but are oligopolistic for a less strict definition of coalition-proofness.
A natural explanation of how a currency becomes a reserve currency is that a large share of government debt is held by constituents of the issuing government. An early version of such a model is Buiter and Eaton (1985).
As in deviations from equilibrium payment with contingent contracts and sovereign risk, holders of debt at time t – 1 do suffer capital losses. The borrower cannot gain by deviating from the implicit contract in perfect equilibrium (see Kletzer and Wright, 2000).