We introduce long-term debt (and a maturity choice) into a standard model of firm financing and investment. This allows us to study two distortions of investment: (1.) Debt dilution distorts firms' choice of debt which has an indirect effect on investment; (2.) Debt overhang directly distorts investment. In a dynamic model of investment, leverage, and debt maturity, we show that the two frictions interact to reduce investment, increase leverage, and increase the default rate. We provide empirical evidence from U.S. firms that is consistent with the model predictions. Using our model, we isolate and quantify the effect of debt dilution and debt overhang. Debt dilution is more important for firm value than debt overhang. Debt overhang can actually increase firm value by reducing debt dilution. The negative effect of debt dilution on investment is about half as strong as that of debt overhang. Eliminating the two distortions leads to an increase in investment equivalent to a reduction in the corporate income tax of 3.5 percentage points. ; The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.
After the huge debt increases in the 1940s, due to the WWII, and in the 1980s due to the emerging markets' debt crises, the debt overhang problem is once again at the center of the academic and political debate because of the recent debt crisis that affected the European countries in 2009. The debt overhang theory explains how an high level of debt distorts the optimal investment decisions and reduces government's incentives, in the debtor country, to undertake the necessary "adjustment policies". A huge literature focuses on the negative effects deriving from a debt overhang condition. In particular, this kind of literature has been mostly used to describe and to study poor and less developed countries. Nowadays instead, the situation is quite different with the Greek case that represents a very peculiar and never experienced situation. Chapter 1 of the thesis starts with an introduction of the sovereign debt overhang problem. Then, since the aim is to study the possible policy interventions able to solve it, the focus is posed on sovereign debt restructuring as a resolution mechanism. A relief intervention can be considered, indeed, as a way to reduce the debt burden for a country struggling with an high level of debt. Descriptions of the restructuring process, of the macroeconomic consequences and of the Greek case are then provided in this chapter in addition to some stylised facts and an event analysis useful to communicate the main messages. In the past, several different strategies of debt restructuring have been implemented and the consequences they produced were often different case by case. It is then interesting to study the effectiveness of the several options that can be used to restructure public debt. For this reason, a very simple theoretical model is developed in Chapter 2 in order to study three different strategies that can be used to solve a sovereign debt overhang problem. In particular, two strategies are based on a debt restructuring process, via face value reduction or rescheduling, whereas a third one is based on conditional-additional official lending. This strategy relies on the idea that the debtor country can benefit of new lending from the official sector, in order to undertake a larger amount of investment. The aim of the model is to represent schematically the functioning of the three restructuring processes to gain insights into their differences and to study their consequences in term of incentives to invest in a "troubled country". An empirical evidence of the debt overhang hypothesis is then provided in Chapter 3. The combination of the sovereign debt crisis of 2009 and the fiscal consolidation policies implemented as a result, makes indeed interesting to study this hypothesis in Europe. The Chapter exploits then a panel dataset for the European countries, between 1995 and 2015, in order to examine the extent to which increased levels of public debt have led to reduced public investment. We start the analysis from basic POLS models and then we expand it gradually to FE, IV and GMM estimation models. The results validate the debt overhang hypothesis and remain robust across various model specifications.
Is the seniority structure of sovereign debt neutral for a government's decision between defaulting and raising surpluses? In this paper, we address this question using a model of debt crises where a discretionary government endogenously chooses distortionary taxation and whether to apply an optimal haircut to bondholders. We show that when the size of senior tranches is small, a version of the Modigliani-Miller theorem holds: tranching just redistributes government revenues from junior to senior bondholders, while taxes and government borrowing costs remain unchanged. However, as senior tranches become sufficiently large, default costs on senior debt transpire into a stronger commitment to repay not only the senior tranche, but also the junior one. We show that there is a lower threshold for senior bonds above which tranching can eliminate default on both junior and senior debt, and an upper threshold beyond which the government defaults also on senior debt. ; The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.
The Great Recession has sent debt levels to a post-WWII high for several advanced economies, reviving the discussion of fiscal consolidation. This paper assesses the macroeconomic implications of tax-based versus spending-based consolidation within the framework of a New Keynesian model with long term government debt. Three results stand out: First, tax-based consolidations are inflationary whereas spending-based ones are deflationary. Second, the net benefits of inflation increase in the average maturity of outstanding debt: inflation revalues debt more efficiently, while distortions due to price dispersion remain unaffected - the maturity effect. Third, as a result, tax-based consolidations can become superior to spending cuts if the average maturity is high enough. Quantitatively, the threshold is two years for US data in 2013. The previous mechanism illustrates the importance of inflation in the consolidation process, even if raising its target rate is considered not to be an option.
We study debt mutualisation in the Euro area. Bearing in mind other existing proposals we provide an alternative Blue, Yellow and Red Bonds proposal: blue, would cover debt up to 60% of GDP, yellow would include debt from 60% up to 90% of GDP, and red would cover debt above 90% of GDP. Although not with joint liability, the rationale behind the Yellow Bonds with a joint issuance is the attraction of liquidity, which would be beneficial, especially for the countries with high yields. This could give more room to public authorities.
A letter report issued by the General Accounting Office with an abstract that begins "This report discusses the Treasury Department's debt management strategies in a period of budget surplus. As the level of debt held by the public has decreased, the Treasury has had to rethink its strategies for best achieving its three goals--having enough cash on hand, minimizing cost over time, and promoting efficient markets. The Treasury has used existing and new debt managing tools in response to the challenges posed by declining debt. In calendar year 2000, the Treasury began two new programs designed to improve market liquidity: regularly reopening existing debt issues rather than creating new issues, and conducting buybacks of about $30 billion in longer-term bonds before they matured, thereby enabling the Treasury to issue more new securities. In addition, higher issuance levels of short-term bills were made possible by eliminating longer-term notes. Capital markets have been adjusting to the reduced supply of Treasury securities. For example, capital market participants have begun using financial instruments other than Treasury securities as pricing tools for transactions. If projected budget surpluses materialize, the current combination of debt auction schedules, issue sizes, and maturities will be unsustainable over the next several years."
International audience ; The political and economic crisis in Europe is often viewed as an indirect consequence of the global financial and economic breakdowns caused by the US "subprime" crisis. European governments themselves tend to underestimate Europe's responsibility for the crisis and seem to prefer to manage the symptoms of the crisis rather than pursue a real recovery from it. This paper argues that the enforced policies are far from achieving an appropriate economic solution for the Eurozone. Moreover, it suggests that, although the European domestic debt situation is very close to the American one, their most recent evolutions and their main causes differ. If the growth of the American debt can partly be explained by macroeconomics imbalances, the causes of the growth of the European domestic debt must be found in a change in the behavior of the financial sector agents. The conclusion advocates for a more radical European policy to solve the debt bubble. ; La crise européenne est souvent perçue comme le produit indirect de la crise financière et de la récession mondiale causée par l'éclatement de la crise des "subprimes" américaine. Les gouvernements européens eux-mêmes tendent à sous-estimer les responsabilités des européens dans la crise et préfèrent en gérer les symptômes plutôt que de travailler à un redressement en profondeur. Dans cet article nous montrons que les politiques mises en œuvre ne peuvent être considérées comme des solutions appropriées à la situation économique. D'autre part, nous suggérons que bien que les niveaux des dettes domestiques européennes et américaines sont proches, leurs causes et leurs évolutions récentes sont différentes. Si l'accroissement de la dette américaine peut s'expliquer par des déséquilibres macroéconomiques, l'augmentation de la dette européenne ne peut s'expliquer que part des changements comportementaux des acteurs du secteur financier. En conclusion nous proposons de mettre en œuvre des solutions plus radicales pour mettre fin à la bulle du crédit.
International audience ; The political and economic crisis in Europe is often viewed as an indirect consequence of the global financial and economic breakdowns caused by the US "subprime" crisis. European governments themselves tend to underestimate Europe's responsibility for the crisis and seem to prefer to manage the symptoms of the crisis rather than pursue a real recovery from it. This paper argues that the enforced policies are far from achieving an appropriate economic solution for the Eurozone. Moreover, it suggests that, although the European domestic debt situation is very close to the American one, their most recent evolutions and their main causes differ. If the growth of the American debt can partly be explained by macroeconomics imbalances, the causes of the growth of the European domestic debt must be found in a change in the behavior of the financial sector agents. The conclusion advocates for a more radical European policy to solve the debt bubble. ; La crise européenne est souvent perçue comme le produit indirect de la crise financière et de la récession mondiale causée par l'éclatement de la crise des "subprimes" américaine. Les gouvernements européens eux-mêmes tendent à sous-estimer les responsabilités des européens dans la crise et préfèrent en gérer les symptômes plutôt que de travailler à un redressement en profondeur. Dans cet article nous montrons que les politiques mises en œuvre ne peuvent être considérées comme des solutions appropriées à la situation économique. D'autre part, nous suggérons que bien que les niveaux des dettes domestiques européennes et américaines sont proches, leurs causes et leurs évolutions récentes sont différentes. Si l'accroissement de la dette américaine peut s'expliquer par des déséquilibres macroéconomiques, l'augmentation de la dette européenne ne peut s'expliquer que part des changements comportementaux des acteurs du secteur financier. En conclusion nous proposons de mettre en œuvre des solutions plus radicales pour mettre fin à la bulle du crédit.
The Definition of Debt Management : Fiscal deficits have become much larger and more widespread than they were. The budget deficit dominates economic policy discussion in the mid - 1980's. Today, there is not a country whether developed or developing without a fiscal defict (In east Eurepean Countries also). Debt is a major government revenue source these days and borrwing is an alternative to*taxation in the short run. But the consequences of government borrowing are different at home and abroad. Because the two forms of finance have different characteristics. There is also another difference of finance for developed and developing countries
Many analysts argue that trade sanctions are ineffective because they generate incentives for evasion. Others object to them as hurting the population of the target country as much as its leaders. We argue that loan sanctions unlike trade sanctions may be self-enforcing, and that they help the population by protecting it from being saddled with "odious debt" run up by dictators to finance looting or repression. In particular, governments could impose sanctions by instituting legal changes that prevent seizure of a country's assets for non-repayment of debt, if the debt was incurred after the sanction was imposed. This would reduce creditors' incentive to extend loans to sanctioned regimes. However, decisions on whether assets can be seized to enforce debt repayment would be subject to bias if they were made ex post and the deciding body asymmetrically valued the welfare of debtor countries and their creditors. Restricting such decisions to cover only future lending would help avoid this time-consistency problem.
This dissertation explores the relationship between sovereign debt ownership, default probabilities, and debt returns, focusing on the increasing domestic debt ownership in devloped countries since the global financial crisis in 2007. It also explains, both theoretically and empircally, how changes in sovereign debt maturity structure would affect the real economy. This dissertation helps advance the study of the linkages between sovereign debt composition, asset prices and the real economy.In the first chapter, I study the relationship bewteen sovereign debt default and debt ownership structure. Major developed countries have experienced a significant run-up in public debt after the onset of the global financial crisis in 2008. However, the impact on sovereign debt ownership varies across countries. Specifically, the share of debt held by domestic banks has increased in GIIPS countries but declined in non-GIIPS countries. I explain the cross-country differences in debt ownership structure using a dynamic equilibrium model with strategic and non-discriminatory defaults, in which sovereign debt can serve as collateral for expanding private investments. The key insight is that the share of debt held domestically is positively correlated with the government's incentive to default. Consequently, the model predicts that the share of domestically-held debt is strictly increasing in total debt only in highly-indebted countries whose debt has low collateral value. My result is consistent with the notion that domestic debt is a committment device for debt repayment. The key policy implication is that changes in debt ownership are important indicators for the optimality of public debt level. Using data from a panel of 11 countries between 2007 and 2014, I find evidence consistent with these predictions.In the second chapter, I study the interaction between monetary and fiscal policies, and how changes in fiscal policies, such as the level of debt and debt maturity composition, would affect inflation, the real economy and asset prices. I developed a three-period equilibrium model, in which monetary policies are modelled as open market operations. In my model, inflation and the term structure of interest rates are jointly determined by monetary and fiscal policies, and therefore Sargent (1981)'s "game of chicken'' problem is avoided. I show from the model that fiscal instruments, such as the primary surplus, and the level and maturity structure of government debt, have important implications on inflations and the term structure of interest rates. I then provide robust empirical evidence on how changes in debt-maturity structure are associated with changes in future inflation using U.S. data. One percent increase in the fraction of short-term debt issued is associated with more than 0.2 percent increase in future inflation of different horizons. Empirical evidecne also shows that changes in the short-end of the maturity structure has the most explanatory power over short- and medium- horizons, whereas changes in the long-end of the maturity structure has the most explanatory power over long- horizons.
[Introduction] Ten years ago, the global economic and financial crisis was at its peak. When ailing investment bank Lehman Brothers filed for insolvency on 15 September 2008, the smouldering crisis on the financial markets became a full-scale firestorm. While falling real estate prices had already been causing problems for banks and other financial institutions, it was the Lehman collapse that fanned the flames of the disaster. The consequences were devastating. In several industrial countries, bank after bank was plunged into financial turmoil, and several had to be propped up by the state. The global economy was upended, with many companies and consumers cutting back on spending because of concerns about the consequences of the crisis on the financial markets. Growth in Germany collapsed by roughly 5%, something that had never before been seen in the post-war era. Governments around the world drew up extensive economic stimulus packages in a bid to counter the collapse of private sector spending. Central banks responded with drastic interest cuts, thus laying the foundations for an ultra-expansive monetary policy that would persist for several years. With the economic stimulus measures and the direct aid for troubled financial institutions (including nationalisation), national governments took on a heavy financial burden. Parts of what had been private debt were converted into public debt. The resulting dramatic rise in sovereign debt, which in some cases had already been running at a high level, caused many market participants and the general public to fear huge inflation, state bankruptcy and even currency reforms. A large number of observers described the situation as hopeless. It was this widespread concern that prompted us, back in 2009, to take an in-depth look at the topic of sovereign debt as part of our Strategy 2030 series. The tenor of our analysis at the time was that while the situation in the financial system and with public finances was very serious, there were ways out of the crisis without having to resort to the state bankruptcies, currency reforms or hyperinflation that people feared. Ten years on, we now know that these doomsday prophecies did not come true. With the exception of Greece, there were no state bankruptcies. Similarly, there was no need for currency reforms. Even the euro, which suffered a severe loss of trust in the interim, did not implode. And there has still not been any significant consumer price inflation in the major industrial countries. In fact, in recent years central banks have been more concerned with preventing deflation. So is this positive outcome merely a »snapshot« of the current moment in time, or is there good reason to suggest that we have weathered the crisis? Is there a risk that these painstakingly achieved successes in stabilising state finances could be lost again the next time the economy takes a nose-dive? What happens if interest rates one day start to spike? And is there a threat of a new debt crisis if highly indebted countries such as Italy destroy the tediously crafted reform successes with another departure in economic policy? These are the questions we want to examine in this study. We will shed some light on the status quo and outline the areas that could pose new risks with the ability to reignite the debt crisis.
Until 1970s external debts did not come as a serious problem for Polish economy. Due to political reasons, the Polish People's Republic rarely took any credits from Western countries, and when it did, all due amounts were repaid in due time. The aim of the article is to present the growth of the Polish external debt, with special consideration of its causes and methods of debt reduction. In order to achieve the aim of the article, a research method of descriptive comparative analysis has been applied. In the conclusions of the paper it is stated – among others – that external credits have been taken in order to decrease economic disproportions between Poland and highly developed countries. Considering the necessity of debt repayment, the due amounts have already become a considerable developmental barrier and a burden not only for the state budget but also for business entities. Undoubtedly, Poland is going to take more credits and to issue foreign bonds in the nearest future. Their use may turn out to be an important factor which shall determine the economic situation of the country.
Until 1970s external debts did not come as a serious problem for Polish economy. Due to political reasons, the Polish People's Republic rarely took any credits from Western countries, and when it did, all due amounts were repaid in due time. The aim of the article is to present the growth of the Polish external debt, with special consideration of its causes and methods of debt reduction. In order to achieve the aim of the article, a research method of descriptive comparative analysis has been applied. In the conclusions of the paper it is stated – among others – that external credits have been taken in order to decrease economic disproportions between Poland and highly developed countries. Considering the necessity of debt repayment, the due amounts have already become a considerable developmental barrier and a burden not only for the state budget but also for business entities. Undoubtedly, Poland is going to take more credits and to issue foreign bonds in the nearest future. Their use may turn out to be an important factor which shall determine the economic situation of the country.
Since the 1950s, the need to raise the debt ceiling, the statutory limit to the borrowing authority of the federal government, has created highly contentious votes in Congress. In some cases, full blown debt ceiling crisis has resulted, in which default appeared a distinct possibility. This paper attempts to explain why periodic debt ceiling crises take place. It concludes that debt ceiling crises are the product of increased national debt and more frequent instances of divided government, coupled with heightened levels of partisanship and party polarization in the post-1950 period. These conclusions are supplemented by case studies of three debt ceiling crises: 1985, 1995-1996, and the summer of 2011.
