Publications
- Investment Cycles and Sovereign Debt Overhang
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- by Gopinath, Gita; Aguiar, Mark; Amador, Manuel
- We characterize optimal taxation of foreign capital and optimal sovereign debt policy
in a small open economy where the government cannot commit to policy, seeks
to insure a risk averse domestic constituency, and is more impatient than the market.
Optimal policy generates long-run cycles in both sovereign debt and foreign direct investment
in an environment in which the first best capital stock is a constant. The
expected tax on capital endogenously varies with the state of the economy and investment
is distorted by more in recessions than in booms amplifying the effect of
shocks. The government’s lack of commitment induces a negative correlation between
investment and the stock of government debt, a "debt overhang" effect. Debt relief is
never Pareto improving and cannot affect the long-run level of investment. Further,
restricting the government to a balanced budget can eliminate the cyclical distortion
of investment.
- Publication Type: WCFIA Working Paper
- Published Date: February 5, 2008
- Field of Interest: International Economics
- Gopinath, Gita, Mark Aguiar, and Manuel Amador. "Investment Cycles and Sovereign Debt Overhang." Working Paper 2008-0034, Weatherhead Center for International Affairs, Harvard University, February 5, 2008.
