Institutions, Public Debt and Foreign Finance

Nicola Gennaioli (), Alberto Martin and Stefano Rossi
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Nicola Gennaioli: http://www.econ.upf.edu/en/people/onefaculty.php?id=p3782

Economics Working Papers from Department of Economics and Business, Universitat Pompeu Fabra

Abstract: We study the role of domestic financial institutions in sustaining capital flows to the private and public sector of a country whose government can default on its debt. As in recent public debt crises, in our model public defaults weaken banks’ balance sheets, disrupting domestic financial markets. This effect leads to a novel complementarity between private capital inflows and public borrowing, where the former sustain the latter by boosting the government’s cost of default. Our key message is that, by shaping the direction of private capital flows, financial institutions determine whether financial integration improves or reduces government discipline. We explore the implications of this complementarity for financial liberalization and debt-financed bailouts of banks. We present some evidence consistent with complementarity.

Keywords: Sovereign Risk; Capital Flows; Institutions; Financial Liberalization; Sudden Stops (search for similar items in EconPapers)
JEL-codes: F34 F36 G15 H63 (search for similar items in EconPapers)
Date: 2009-08
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Persistent link: http://EconPapers.repec.org/RePEc:upf:upfgen:1170

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