Discussion Paper No.2004

Abstract :
As one countermeasure against the COVID-19 pandemic, governments in most countries are now engaging in large-scale fiscal transfers, which are mostly financed by debt. With huge amounts of government debt already accumulated, governments might partially default on its debt by debt repudiation. We study the long-term effects of debt repudiation on fiscal sustainability using an endogenous growth setting. Debt repudiation lowers the sustainable debt–capital ratio if the initial repudiation ratio is sufficiently low. It also enhances fiscal sustainability by increasing the unstable stationary debt–capital ratio. However, if the initial repudiation ratio is not low, then the increased debt repudiation increases the debt-capital ratio, raising the income tax rate, and degrades fiscal sustainability.

Keywords : debt repudiation, fiscal sustainability, partial default
JEL classifications: E62, G28, H63