National Investment Policies with Debt - 趙永祥的數位歷程檔

In general, the ability of foreign lenders to punish a sovereign borrower is limited. Therefore, the absence of a commitment to repay implies that whether the country meets its debt obligations or defaults depends on the country’s willingness to pay rather than its ability to pay. In the rest of the paper, following the literature on sovereign risk, we will focus on the case where foreign lenders can impose (limited) direct punishments on defaulting borrowers. Specifically, we assume that creditors can impose sanctions proportional to the country’s output.

As a result, the country’s repayment can never exceed the cost of the sanctions. Further, the absence of a commitment to an investment strategy implies that the country has the option of enjoying a first-period consumption binge and investing little. This lowers second-period output and reduces the cost of sanctions, weakening their power to deter default. Thus, potential competitive creditors have to determine how much they can lend to ensure a sufficient level of public investment that makes default more costly than repayment. Thus, once the credit is extended, the borrower decides either to amortize the debt at the contracted rate or to default and pay the punishment, which we call debt distress.