The Political Economy of International Debt

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The lack of a supranational legal authority places important limitations on the integration of world capital markets. The ongoing negotiations over debt rescheduling between major Latin American debtors and their Western bank creditors illustrate the kind of problems which can arise. Recently, there has been considerable progress in understanding the economics of debt-restructuring negotiations, and the first part of this project builds on that research. The work will involve bargaining-theoretic approaches to analyzing implicit sovereign debt-contracts. There will also be work attempting to compare different assessments of the possible costs to a country of repudiating its debt. Another part of the project involves developing a two-country, general-equilibrium model of the bargaining over gains from trade in both goods and financial assets. The analysis represents an attempt to provide a fully specified model of country risk. The last part of this project deals with exploring how electoral pressures within debtor countries can cause a cyclical, over valuation of the real exchange rate, and over accumulation of foreign debt. The starting point will be a recently developed framework for analyzing political budget cycles. This research is important because it will provide a better understanding of the economic relations between debtor and creditor trading partners.