International perspectives on debt, growth, and business cycles
We consider a model of international sovereign debt where repayment is enforced because defaulting nations lose their reputation and consequently, are excluded from international capital markets. Underlying the analysis of reputation is the hypothesis that borrowing countries have different, unobservable, attitudes towards the future. Some regimes are relatively myopic, while others are willing to make sacrifices to preserve their access to debt markets. Nations' preferences, while unobservable, are not fixed but evolve over time according to a Markov process. We make two main points. First we argue that in models of sovereign debt the length of the punishment interval that follows a default should be based on economic factors rather than being chosen arbitrarily. In our model, the length of the most natural punishment interval depends primarily on the preference parameters. Second, we point out that there is a more direct way for governments to regain their reputation. By offering to partially repay loans in default, a government can signal its reliability. This type of signaling can cause punishment interval equilibria to break down. We examine the historical record on lending resumption to argue that in almost all cases, some kind of partial repayment was made.
There are two striking aspects of the recovery from the Great Depression in the United States: the recovery was very weak and real wages in several sectors rose significantly above trend. These data contrast sharply with neoclassical theory, which predicts a strong recovery with low real wages. We evaluate whether New Deal cartelization policies designed to limit competition among firms and increase labor bargaining power can account for the persistence of the Depression. We develop a model of the intraindustry bargaining process between labor and firms that occurred with these policies, and embed that model within a multi-sector dynamic general equilibrium model. We find that New Deal cartelization policies are an important factor in accounting for the post-1933 Depression. We also find that the key depressing element of New Deal policies was not collusion per se, but rather the link between paying high wages and collusion.