Friday, October 29, 2010

Sovereign debt and the age pyramid

The papers about sovereign debt I come across always assume that the debt is held by some social planner who implicitly is acting on the behalf of representative and identical agents. But not all international debt is held by governments, and not everyone in a country has the same opinions regarding this debt.

Martín Gonzalez-Eiras deviates from this literature by including demographics, and in particular how there can be intergenerational conflict about the handling of debt. Obviously, reneging has different consequences whether you are young or old. He also looks at how outcomes can differ if the demographic structure of a country changes.

The paper highlights one interesting mechanism that should provide larger incentives to prevent default. Important transfers between generations are welfare improving, and they can further improved by having access to international insurance. This implies that these intergenerational transfers act as international collateral, and thus make it possible to obtain self-enforcing contracts. A country with a large retirement pension system provided by the state is this less likely to default and more likely to obtain gains in efficiency through participation in international insurance.

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