 Sovereign default and capital controlsRobert A. McDowall Review of International Economics, 2021, vol. 29, issue 4, 1025-1045 Abstract: This paper explores a role for capital control policies in enhancing a sovereign’s commitment to repay its debts. I study the equilibrium of an economy in which a sovereign must finance some expenditure, is constrained by the savings decisions of domestic households, and cannot discriminate between foreign and domestic lenders. I show that capital controls are crucial for implementing an equilibrium with lending from abroad and that optimal controls exhibit threshold behavior, instituted when domestic disposable income is low. Controls impose a wedge between the bond prices faced by foreign and domestic lenders. By crowding in domestic lending, and increasing the value of repayment, the sovereign can credibly enforce future repayment. The implementation result is robust to the introduction of labor taxes and uncertainty over the cost of default. These results offer a novel rationale for procyclical capital controls, distinct from conventional theories that stipulate controls be employed countercyclically to regulate capital inflows during expansions. The optimal policy is characterized and empirical implications are discussed. Date: 2021 Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:bla:reviec:v:29:y:2021:i:4:p:1025-1045 Ordering information: This journal article can be ordered from Access Statistics for this article Review of International Economics is currently edited by E. Kwan Choi More articles in Review of International Economics from Wiley Blackwell |
Is your work missing from RePEc? Here is how to contribute.
Questions or problems? Check the EconPapers FAQ or send mail to .
EconPapers is hosted by the
School of Business at Örebro University.