Austerity

Harris Dellas () and Dirk Niepelt

The Economic Journal, 2021, vol. 131, issue 634, 697-712

Abstract: We study the optimal debt and investment decisions of a sovereign with private information. The separating equilibrium is characterised by a cap on the current account. A sovereign repays debt amount due that exceeds default costs in order to signal creditworthiness and smooth consumption. Accepting funding conditional on investment/reforms relaxes borrowing constraints, even when investment does not create collateral, but it depresses current consumption. The model contains the signalling elements emphasised by creditors in the Greek austerity programmes and is consistent with the reduction in the loans issued by Greece and their interest rate following the 2015 election.

Date: 2021
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Related works:
Working Paper: Austerity (2014)
Working Paper: Austerity (2014)
Working Paper: Austerity (2014)
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