Proofs of Propositions 3 and 4
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I am thankful for discussions with Andre Faria, Patrick Kehoe, Narayana Kocherlakota and Cyril Monnet. I am also indebted to participants in the Midwest Macroeconomics Conference (Atlanta, 2001) and the SED Meetings (Stockholm, 2001).
See Eaton and Gersovitz (1981) for a seminal contribution in this area. More recently, Arellano (2005) and Aguiar and Gopinath (2006) have considered environments in which borrowers suffer exclusion with an exogenous probability of regaining access.
This loan only brought temporary relief to Bulgaria, as the country faced severe financing needs again in 1901.
The rationale behind monetary control was to guarantee the foreign exchange value of the domestic currency, in which repayments of loans were made. For instance, after its 1898 default, Brazil had to accept a deflationary recipe from its bankers. Similarly, in 1902, the National Bank of Bulgaria partially relinquished control over its ability to issue money.
Certainly, I am abstracting from moral hazard considerations. This does not undermine the point that the paper tries to make: the reaction of lenders to default is not automatically denial of fresh credit, but a verification of the state and, perhaps, renewal of lending.
In calling this contract a standard debt contract I am following a convention in the costly state verification literature, and more in particular Chang (1990) and Townsend (1979). Throughout the paper, default will be understood as those instances in which the government cannot make a payment high enough to reimburse the lender for the original loan. In other words, default occurs whenever pt (ρt-1,yt,mt)<x.