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A Note on Allowing State Bankruptcy

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U.S. states are sovereign entities and can’t declare bankruptcy as cities and municipalities. This paper examines the impact of a switch in sovereign bankruptcy rules that allows declaring bankruptcy from an economics model perspective. Allowing bankruptcy increases ex-ante risks for the government to refuse repayment, but provides ex-post benefits of reducing default costs and saving federal bailouts. This paper provides a simple framework to analyze this tradeoff. Whether allowing for bankruptcy increases or decreases borrowing costs depends on the level of income and borrowing for the government.

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  • Minjie Deng, 2024. "A Note on Allowing State Bankruptcy," Discussion Papers dp24-05, Department of Economics, Simon Fraser University.
    • Handle: RePEc:sfu:sfudps:dp24-05
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