The Costs and Consequences of Sovereign Borrowing

In this lecture, I revisit whether sovereign debt markets have delivered on their promise of fostering growth and enhancing risk sharing in emerging and developing economies. I use data and models to cast a skeptical view on the welfare consequences for domestic citizens of increasing or facilitating access to sovereign debt markets in these economies. Using data from the boom in sovereign debt lending between 1970 and the turn of the 21st century, I show that emerging economies that borrowed relatively more experienced slower growth and suffered from greater volatility in output, government expenditures, and private consumption. Indeed, the data suggest that sovereign debt markets are engines of volatility rather than development. Using simulations from a quantitative debt model, I show that small disagreements between private households and politicians regarding inter-temporal discounting and risk aversion implies that gaining access to sovereign debt markets is welfare reducing for the domestic citizenry. In regard to improving the efficiency of debt markets, in a model with self-fulfilling runs it is the case for a wide range of parameters that the introduction of a perfectly informed lender of last resort may also be welfare reducing. The lecture concludes by cautioning against the dominant policy paradigm that seeks to facilitate international debt flows to emerging and developing economies.