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International Tax and Public Finance

Erschienen in:

01.08.2016

Public debt, bailouts, and common bonds

verfasst von: Zarko Kalamov, Klaas Staal

Erschienen in: International Tax and Public Finance | Ausgabe 4/2016

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Abstract

We look at a model where countries of different sizes provide local public goods with positive spillovers. Matching grants can give rise to optimal expenditure levels, but countries can induce bailouts. We study the characteristics of these bailouts in a subgame-perfect Nash equilibrium and how these characteristics are affected by the introduction of common bonds. Partial substitution of common for sovereign bonds has two implications. First, it lowers the average and marginal borrowing costs of countries which may be eligible for bailouts. This effect leads to higher borrowing in these countries irrespective of their bailout expectations. Second, the lower borrowing costs mitigate the incentives of countries to induce a bailout and, therefore, constrain the parameter set for which a soft budget constraint equilibrium exists. As a result, the introduction of common bonds can also be in the interest of those countries that provide the bailouts.

Vorheriger Artikel The elasticity of taxable income and income-shifting: what is “real” and what is not?

Nächster Artikel Common labor market, attachment and spillovers in a large metropolis

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The possible advantages, disadvantages, and institutional aspects of euro bonds are further discussed outside the context of a formal model by Issing (2009), De Grauwe and Moesen (2009), Favero and Missale (2010), Bishop et al. (2011), Eijffinger (2011), Hellwig and Philippon (2011), Boonstra and Bruinshoofd (2013), Claessens et al. (2012), and Gilbert et al. (2013).

The positive relationship between public debt and interest rates is supported by early empirical research by Edwards (1984) and more recently by Chung and Turnovsky (2010).

The cost of financing usually depends on the debt-to-GDP ratio. However, due to the exogenous per capita income y, \(b_i\) can be interpreted as a proxy for debt to GDP of country i, which is given by \(n_ib_i/n_iy=b_i/y \propto b_i\).

A similar modeling of spillovers is done by Besley and Coate (2003). In contrast to their model, there is no heterogeneity among individuals within a country in our model, but heterogeneity across countries (i.e., differences in country size). Feidler and Staal (2012) demonstrate that these differences can be seen as a proxy for heterogeneity among individuals within a country.

Note that this differs from the first-best outcome that would be determined when the values of all \(\delta _j\) are known. The derivation of this first-best outcome, however, does not only differ from the derivation in this subsection by taking the spillover effect into account, as it would also differ with respect to the information asymmetries in decentralized decision making studied in the next subsection. Since the system of matching grants and the bailouts are motivated by the spillover effect, we follow Wildasin (1997) and Crivelli and Staal (2013) and take as a benchmark the outcome that would be achieved if the spillover effect is taken into account. We thank two anonymous referees for pointing this out to us.

The second derivative with respect to \(\underline{m_i}\) is always negative, and thus, the second-order condition is always satisfied.

Since countries \(j\ne i\) are identical, \(b_j\) measures the per capita debt of all countries \(j\ne i\) and, therefore, determines the common interest rate.

Under this condition, country i issues the maximum allowed amount of common bonds. In order to see this, note that for any substitution of national by common debt, without increasing the overall level of \(b_i\), less taxes are necessary to finance a given level of \(g_{i2}\) and private consumption \(c_{i2}\) goes up.

Note that homogeneity of degree between 0 and 1 would violate the assumption that \(r^{\prime \prime }\) is positive. Furthermore, for \(\delta _i<\delta _j\), this condition is always satisfied, while for \(\delta _i>\delta _j\) recall from Sect. 3 that \(\delta _j=p^H\delta _\mathrm{high}+(1-p^H)\delta _\mathrm{low}\) with \(p^H\) close to 1, which implies that in the latter case, this lower bound for \(\bar{b}\) is close to 0.

Equation (31) holds both in a soft and hard budget constraint cases, as the bailout decision remains given by (21), while \(\partial \underline{m_i}/\partial b_i\) becomes \(\partial \underline{m_i}/\partial b_i = \left( 1+r_i\left( b_i^*\right) \left( 1+\varepsilon _i^*(1 -\bar{b}/b_i^*)\right) \right) (1 +2\underline{m_i})/(1+2\underline{m_i}+2g_{i2})>0\).

Use (16), (36a), (36b), (36c), and (36d).

See, e.g., Claessens et al. (2012) for a survey of proposals.

Akai, N., & Silva, E. C. D. (2009). Interregional redistribution as a cure to the soft budget syndrome in federations. International Tax and Public Finance, 16(1), 43–58.CrossRef

Beber, A., Brandt, M., & Kavajecz, K. (2009). Flight-to-quality or flight-to-liquidity? Evidence from the Euro-area bond market. Review of Financial Studies, 22(3), 925–957.CrossRef

Beetsma, R., & Mavromatis, K. (2014). An analysis of eurobonds. Journal of International Money and Finance, 45, 91–111.CrossRef

Bernoth, K., von Hagen, J., & Schuknecht, L. (2012). Sovereign risk premiums in the European government bond market. Journal of International Money and Finance, 31, 975–995.

Besley, T., & Coate, S. (2003). Central versus local provision of public goods: A political economy analysis. Journal of Public Economics, 87(12), 2611–2637.CrossRef

Bishop, G., Boonstra, W., Bos, M., Gilbert, N., Kamalodin, S., Karsenti, R., et al. (2011). An EMU bond fund proposal. European League for Economic Cooperation.

Boonstra, W. W., & Bruinshoofd, W. A. (2013). Conditional euro t-bills as a transitional regime. In M. Balling, P. Egger, & E. Gnan (Eds.), States, banks and the financing of the economy: Fiscal policy and sovereign risk perspectives. Vienna: SUERF.

Botta, A. (2011). Fiscal policy, eurobonds and economic recovery: Some heterodox policy recipes against financial instability and sovereign debt crisis. MPRA Paper 33860, University Library of Munich, Germany.

Chung, K., & Turnovsky, S. J. (2010). Foreign debt supply in an imperfect international capital market: Theory and evidence. Journal of International Money and Finance, 29(2), 201–223.CrossRef

Claessens, S., Mody, A., & Vallée, S. (2012). Paths to eurobonds. IMF Working Paper 12/172.

Crivelli, E., & Staal, K. (2013). Size, spillovers and soft budget constraints. International Tax and Public Finance, 20(2), 338–356.CrossRef

De Grauwe, P., & Moesen, W. (2009). Gains for all: A proposal for a common euro bond. Leuven: University of Leuven.

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Edwards, S. (1984). LDC foreign borrowing and default risk: An empirical investigation, 1976–80. American Economic Review, 74(4), 726–734.

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Titel: Public debt, bailouts, and common bonds
verfasst von: Zarko Kalamov
Klaas Staal
Publikationsdatum: 01.08.2016
Verlag: Springer US
Erschienen in: International Tax and Public Finance / Ausgabe 4/2016
Print ISSN: 0927-5940
Elektronische ISSN: 1573-6970
DOI: https://doi.org/10.1007/s10797-016-9395-2

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