ESSAYS ON GOVERNMENT DEBT AND DEFAULT

This dissertation proposes theories of government debt and default in the context of external sovereign debt as well as domestic public debt. The essential contribution of this dissertation is to model limited commitment of repaying the debt from the perspective of the borrowing government. Chapter 1 provides a theory of external sovereign debt default. It introduces limited commitment into a dynamic optimization model of sovereign debt and strategic default. The idea of limited commitment contrasts with the existing literature, which assumes that the sovereign cannot commit to repay. Estimating the model for Argentina shows that limited commitment improves the model's ability to match the data in many ways, in particular the level of debt, the level of spreads, and the countercyclicality of the trade balance. Welfare is increasing with the degree of commitment only for low levels of debt, and most of the gains only accrue at relatively high levels of commitment. Chapter 2 extends the model in Chapter 1 to domestic public debt markets. In the model, the government borrows from domestic households to smooth its expenditure. A quantitative analysis calibrated to the Greece economy shows that the model is able to sustain an equilibrium with both recurrent defaults and a high level of debt as observed in the data. The model predicts a default and interest rate spike in the period when the Greek government defaulted, and the dynamics of the model are consistent with stylized facts of the Greek economy such as countercyclical interest rate spreads and countercyclical primary balance. An alternative model specification is also considered where tax policy is countercyclical. Compared to the baseline model where tax rate is constant, countercyclical tax policy significantly reduces the likelihood of default and lowers interest rate spreads, but does not have any significant effect on the level of debt. Chapter 3 adapts the endogenous gridpoints method to solve a simplified version of the model in Chapter 1. The paper shows that the endogenous gridpoints method yields model solution that is very close to the discrete-state-space method widely used in the literature. However, there does not seem to be any gain in computation time