The Structure of Public Debt in Argentina: Lessons and Perspectives

Transcription

1 Iner-Amercan Developmen Bank Banco Ineramercano de Desarrollo Lan Amercan Research Nework Red de Cenros de Invesgacón Research Nework Workng paper #R-423 The Srucure of Publc Deb n Argenna: Lessons and Perspecves by Francsco Buera* Juan Pablo Ncoln** Gerardo della Paolera** Pablo Gudo** *Unversdad Torcuao D Tella and Unversy of Chcago **Unversdad Torcuao D Tella February 2001

2 Caalogng-n-Publcaon daa provded by he Iner-Amercan Developmen Bank Felpe Herrera Lbrary The srucure of publc deb n Argenna : lessons and perspecves / by Francsco Buera [e al.]. p. cm. (Research Nework workng paper ; R-423) Includes bblographcal references. 1. Debs, Publc--Argenna. 2. Argenna--Economc condons Argenna-- Economc condons I. Buera, Francsco. II. Iner-Amercan Developmen Bank. Research Dep. III. Lan Amercan Research Nework. IV. Seres S846--dc Iner-Amercan Developmen Bank 1300 New York Avenue, N.W. Washngon, D.C The vews and nerpreaons n hs documen are hose of he auhors and should no be arbued o he Iner-Amercan Developmen Bank, or o any ndvdual acng on s behalf. The Research Deparmen (RES) produces he Lan Amercan Economc Polces Newsleer, as well as workng papers and books, on dverse economc ssues To oban a complee ls of RES publcaons, and read or download hem please vs our web se a: hp:// 2

3 1 Inroducon * The purpose of hs paper s o use he Argenne experence wh deb managemen durng he las wo decades o assess he usefulness of recen heorecal developmens and o draw prelmnary conclusons regardng polcy mplcaons. The recen crss n Eas Asan counres, as well as he Mexcan crss of 1995, drew he aenon of many o deb managemen ssues as a poenal explanaon of he crss. In parcular, ssues regardng ndexaon and maury of governmen deb play probably he mos promnen role ever n debaes on he explanaon of balance of paymens and currency crss. Ths recen emphass on deb managemen probably has o do wh he fac ha he radonal scapegoa he fscal defc canno be blamed n hese nsances, as none of he counres affeced by he recen crss had a bad fscal record a he me. One of he problems wh he recen dscusson of deb managemen, hough, s ha he economc leraure has very lle o say abou. Neuraly heorems he Rcardan Equvalence beng he mos noable example are commonplace. Very few models are useful n gudng emprcal analyss, and mos of hem have been very recenly developed and no ye fully undersood. Of course, a problem for polcans s ferle ground for academcs; he unresolved and neresng quesons regardng he managemen of governmen deb can provde numerous producve lnes of nqury. Gven hese lmaons, hs paper wll no provde a deep undersandng of many of he problems posed, raher, wll survey he mos mporan ssues addressed n he recen leraure, meshed wh recen Argenne economc hsory. We hnk hs survey s useful one n solang he ssues ha seem key n undersandng he crss ha occurred n Argenna durng he perod and n exracng lessons regardng polcy mplcaons. Recen Argenne hsory s, by all means, a very rch expermen o analyze. We wll cover roughly, from he early sevenes o he end of he Tequla crss. Durng hs perod, we can observe wo very mporan bankng reforms, wh a lberalzaon of acvy and openng o nernaonal capal movemens. The experence also provdes several balance of paymens and currency crses of varyng dmensons, several years of defaul n nernaonal capal markes, hree very clear hypernflaon epsodes, ogeher wh smaller spkes n nflaon raes, over half a dozen sablzaon plans wh dfferen duraons, a so far very successful currency board and * The auhors would lke o hank Gullermo Calvo, Eduardo Fernández Aras, José Lus Maa and Andrés Velasco for helpful commens and dscussons. 3

4 several bank pancs. From an analycal perspecve, you canno ask for more. The focus n hs case s herefore very well jusfed. The paper s organzed n hree secons. The frs brefly revews he las weny years of Argenna s macroeconomc and deb hsory. The purpose of hs secon s o hghlgh he facs ha seem o us relevan n undersandng he nerplay beween governmen deb and he evoluon of he man macroeconomc varables. Thus, boh he dvson of he whole perod no sub-perods and he facs ha wll be sressed are chosen o focus on he role of governmen deb. In he second secon, we offer a survey of he Argenne experence, guded by several aemps n he leraure o undersand he macroeconomc role of governmen deb. The common feaure of he models used s ha governmen deb, as well as s maury and denomnaon, are bascally exogenous. Thus, he focus of hs leraure s on he effecs of ceran deb feaures on macroeconomc oucomes. The survey wll begn by usng he governmen budge consran, as n Sargen (1983), o hghlgh he neracons beween fscal polcy and moneary polcy, where deb plays a key bu unexplaned role. We wll hen move o models ha sress he maury srucure of he deb and exhb mulple equlbra, as n Calvo (1995). We wll also nerpre he evdence usng a famly of models ha analyze opmal lendng polcy wh enforcemen consrans, as n Bulow and Rogoff (1989), Marce and Marmon (1992) and Albuquerque and Hopenhayn (1997). We conclude he secon by consderng a seres of papers ha sress he role of he bankng secor, as n Díaz-Alejandro (1985), Velasco (1989) and, more recenly, Burnsde, Echenbaum and Rebelo (1998). In all cases, we wll brefly skech he heory and explore he evdence o see how relevan ha heory seems o be for he crss experenced by Argenna durng he perod. In he hrd secon we offer an alernave and shorer survey. We consder heorecal developmens wh mplcaons regardng he opmal managemen of governmen deb. The focus of he papers revewed n hs secon s herefore normave. The am n hs secon s o perform some prelmnary evaluaons regardng he opmaly of some feaures of deb managemen n Argenna. We wll consder varaons on he opmal axaon leraure poneered by Lucas and Sokey (1983) and Barro (1979). A fnal secon conans some polcy mplcaons derved from he analyss ogeher wh concludng remarks. 4

5 2 Macroeconomc and Deb Evoluon The analyss of he paper covers roughly he perod from he early 1970s o he lae 1990s. As he focus s on he behavor of governmen deb, we dvde hs general dscusson no four perods accordng o he ably of he governmen o borrow n domesc and foregn markes. In he frs perod, from 1971 o 1976, he economy was closed o capal movemens. The deb as a share of GDP was small, and was manly domesc deb. For nsance, n he early 1970s he deb o GDP rao was around 7.5%, and foregn deb accouned for only 20% of he oal. The frs years of he decade were characerzed by fscal defcs close o 2% of GDP. As Argenna was a closed economy, he governmen had no access o foregn borrowng, so he defcs were fnanced by eher domesc deb or segnorage. In 1973 and 1974 he defc jumped o 6%, whle n 1975 skyrockeed o 12%. These ncreased fscal mbalances were fnanced by boh segnorage 1975 s he year of he frs hypernflaon of he perod consdered and by domesc deb. Thus, by he end of 1976, he deb o GDP rao was over 20%. The second perod, roughly from 1977 o 1982, ncludes he begnnng of he deb crss. Ths perod was characerzed by a subsanal reducon n arffs and he openng of he economy o he nernaonal capal marke. Two polcy changes are key n deermnng he evoluon of he deb. The frs was he deregulaon of he fnancal secor. Ths deregulaon mpled a free marke-deermned neres rae ogeher wh free enry no he ndusry. These reforms, along wh depos nsurance guaraneed by he governmen, are key n undersandng he developmen of governmen deb for he followng decade, as we wll argue below. Depos nsurance s effecvely conngen deb of he governmen because, n he case of a bankng crss, he lables of he fnancal secor become lables of he Cenral Bank. The second s he sablzaon aemp, launched n 1978, ha ncluded a pre-announced crawlng peg. To enforce he credbly of he plan, an exchange rae guaranee was offered by he governmen. Ths perod was characerzed by access o he nernaonal capal markes, and he governmen fnanced he defc wh foregn deb, manly bank deb. By he end of hs perod, a generalzed bankng crss forced he governmen o back an mporan poron of deposs. A he same me a balance of paymens crss developed ha led o a sharp devaluaon of he domesc currency. The exchange rae guaranee mpled an addonal burden for he governmen. 5

6 Sarng n 1982, he governmen could no comply wh hese deb oblgaons and unlaerally declared defaul. Ths even forced he governmen ou of he nernaonal capal marke unl 1991, so fscal mbalances had o be fnanced by eher domesc cred or segnorage. Ths perod wnessed wo hypernflaons and several balance of paymen crss. A very neresng feaure of hs perod, whch we wll analyze n he las secon, s ha whle he governmen dd no fulfll oblgaons on foregn deb, ssued domesc bonds denomnaed n US dollars and never defauled on hese bonds. Thus, whle defaulng on some conracs, managed o honor ohers was a year of crss. A balance of paymen crss developed no a hypernflaon, reachng more han 200% a monh n June. A sablzaon perod sared n July 1989 and wo oher developmens are mporan regardng he evoluon of governmen deb. The frs was he Bonex plan n January 1990, whch swapped shor-erm bank deposs for long-erm bonds, and he second was he Brady Plan n 1992, an agreemen wh credors o end he defaul perod. The Brady Plan s he sarng dae of he las perod, n whch a successful currency board was mposed and a perod of reganed confdence n nernaonal capal markes begns. The governmen could floa bonds abroad and, afer several years of sably, he neres rae pad was only a few pons above he T-Bll rae. The mos neresng epsode n hs perod s he severe bankng crss ha developed a he begnnng of 1995, followng he urmol of nernaonal capal markes afer he Mexcan devaluaon n December These developmens are relevan n undersandng he dynamcs of oal governmen deb, depced n Fgure 1. The fgure represens oal federal governmen deb, ncludng bonds, bankng deb, deb wh oher governmens and fnancal nsuons, denomnaed n 1996 US dollars. The oal deb ncreased subsanally from 1975 and 1982, he yearly average beng 30%. Durng hs perod he governmen borrowed abroad o fnance no only he defc, bu also he conngen deb ha depos and exchange rae nsurance mpled. Then, he deb crss develops and he deb of he governmen grows a a much lower rae. In fac, he deb n 1991 s only slghly above he 1983 fgure. The changes n he sock of deb have o do wh he accumulaon of arrears and he ssung of domesc bonds, some volunary and some mandaory. Sarng n 1991, as he governmen reganed access o nernaonal capal markes, he deb sared o grow agan a a yearly average of 10%. 6

7 To provde an dea of he relave sze of he deb, Fgure 2 depcs he deb o GDP rao. Two man developmens affec hs fgure relave o Fgure 1. The frs, GDP growh, s obvous. The second, whch s very mporan for Argenna durng he perod, s real exchange rae movemen beween he peso and he dollar. The GDP and peso-denomnaed deb are deflaed usng peso prce ndces, whle dollar-denomnaed deb s deflaed usng US prce ndces and he nomnal exchange rae beween he peso and he dollar. Any devaon n PPP wll affec he fgure. Ths s mporan o ake no accoun, because here wll be srong movemens n he deb o GDP rao ha are no assocaed wh fscal polcy bu wh relave prce changes, and here were subsanal relave prce changes n Argenna durng he perod consdered here. Thus, whle oal deb ncreased from almos 20 bllon o almos 50 bllon dollars from 1975 o 1980, he deb o GDP rao acually decreased. As we menoned above, hs s because here was n fac GDP growh durng he perod, bu obvously no of he same magnude as he deb growh. Wha explans he behavor s a srong apprecaon of he peso, so he relave value of dollar-denomnaed deb decreased. The sharp ncrease of he deb o GDP rao n 1982 reflecs he srong deprecaon of he peso. Thus, he perod s characerzed by an ncrease n he deb o GDP rao, whch s smooh f we absrac from real exchange rae movemens. The fla poron of he fgure durng mos of he 1980s reflecs he fac ha he governmen had lle access o cred markes, a fac ha s also suggesed by Fgure 1. The spke n 1989 s essenally explaned by a srong deprecaon of he peso and, o a lesser exen, a srong recesson. The hrd perod s characerzed by a roughly seady and lower value of he rao. Agan, an mporan explanaon of he reducon s he apprecaon of he peso and he hgh growh raes experenced by Argenna durng he perod. Anoher mporan facor ha explans hs behavor s he prvazaon of sae-owned companes n he begnnng of he decade. The governmen acceped s own bonds as a mean of paymen n he aucons, so he prvazaon process was a bond-company swap o some exen. Thus, whle he deb o GDP rao s low by nernaonal sandards, and seady, he pcure shows ha sudden real exchange rae apprecaons can subsanally modfy hs rao o he exen ha an mporan share of he deb s denomnaed n foregn currency. Ths s mporan because makes a relevan dsncon beween bonds ndexed o domesc nflaon and foregn currency-denomnaed bonds. In Fgure 3, we plo he rao of oal deb denomnaed n pesos o oal deb denomnaed n foregn 7

8 currency. As he fgure clearly shows, he share of peso-denomnaed deb was only mporan (abou a hrd of oal deb) durng he 1970s, wh a modes ncrease n he 1990s. Fgure 4 shows he rao of non-ndexed deb o ndex deb. Ths shows ha non-ndexed deb was mporan durng he lae 1970s, vrually dsappeared durng he 1980s and experenced a modes ncrease n he 1990s. In fac, he wo graphs show ha essenally all of he pesodenomnaed deb ssued durng he 1990s s non-ndexed deb. Overall, hese pcures show ha whle he deb o GDP rao s low, he exposure of hs number o real exchange rae flucuaon s mporan. More han nney percen of he deb s dollar-denomnaed, whch means ha a crss ha enals a real exchange rae deprecaon would subsanally affec ha rao. For nsance, o ncrease he deb o GDP rao from 25% o 40%, he governmen should have a defc (ncludng neres paymens) 3 pons hgher han he growh rae of oupu susaned for 10 years. A crss ha conveys a 50% real deprecaon a number ha s n lne wh he recen experence would acheve ha change nsananeously. Agan, he reason for hs s ha more han 90% of he deb s ndexed o he exchange rae raher han o he domesc prce level. Anoher feaure of he deb ha s relevan for he dscusson ha follows s s maury. Recen heorecal developmens have sressed he role ha shor-erm maury has n rggerng macroeconomc crss. Fgure 5 depcs he dsrbuon of maury for seleced years: 1978, he year when he ncrease n foregn borrowng began, 1982, he year of he bankng, balance of paymens and deb crses, 1988, he year before he wors hypernflaon epsode and 1996, he las year we sudy. A clear paern of he graph s he change n maures ha occurred durng he perod. The sablzaon perod of he lae 1970s nhers a dsrbuon of maures hghly based owards shor-erm deb. Almos a hrd of he deb was due whn a year, whle more han 60% was due n he frs four years. By 1982, he bas owards shor-erm deb was even sronger. By he end of he 1980s, less han 10% of he deb was due n he followng four years. Ths reflecs more he negoaons beween he governmen and he credors ha ook no accoun he nably of he governmen o generae surpluses o pay he deb more han an explc polcy of managng he maury of he deb. However, a remarkable feaure s ha he deb expanson of he 1990s evden n Fgure 1, mos of volunary deb floaed by he governmen n nernaonal capal markes, was managed o preserve a favorable maury srucure. Thus, less han 40% of he deb s due n he followng four years. The dsrbuon of 8

9 maures n 1996 reproduces much more closely he dsrbuon of maures of 1988 raher han he lae 1970s. Fnally, a remark regardng Cenral Bank deb s n order. Durng he deb crss perod, an mporan source of fnancng of he cenral governmen was carred ou hrough he fnancal sysem, essenally by ncreases n he reserve requremens of commercal banks n he Cenral Bank. Thus, an mporan poron of savngs n he form of deposs, raher han prvae nvesmen, fnanced he cenral governmen. Fgure 6 depcs he lables of he cenral bank, wh he fnancal sysem only a fracon of he lables of he fnancal sysem. The graph shows ha he defcs of he lae 1970s were n par fnanced hrough he fnancal sysem, bu he mos remarkable feaure of he graph s subsanal borrowng hrough he fnancal sysem durng he deb crss. Ths s a key elemen o undersand some developmens of he perod 1989 o The mplc maury srucure of hs deb s he maury srucure of he fnancal sysem s lables, manly deposs. Durng he perod, he mos common maury for deposs was a week, almos never above a monh. Thus, he governmen was ndebed wh he prvae secor hrough he fnancal sysem a very shor-erm maures. In January 1991, he so-called Bonex Plan swapped he deposs of he fnancal sysem (essenally lables of he Cenral Bank) no 10-year governmen bonds. Ths was a sep prevous o he nroducon of he currency board. In summary, he behavor of governmen deb s explaned by fscal polcy as usual plus hree oher man feaures. Frs, he realzaon of saes agans whch he governmen nsured he prvae secor, such as exchange rae nsurance and depos nsurance. To he exen ha he nomnal exchange rae s devalued or banks go bankrup, he dollar lables of banks or of prvae debors become paral or oal lables of he governmen. Ths explans he subsanal ncrease n deb from 1980 o Second, flucuaons n he real exchange rae affec he value of he deb subsanally, o he exen ha mos ndexaon uses he nomnal exchange rae. Thrd, an mporan par of governmen borrowng can be maeralzed hrough he fnancal secor, and hs opon becomes aracve when nernaonal capal markes are closed o he governmen. 3 Concepual Issues 9

10 In hs secon, we very brefly dscuss he man resuls regardng deb managemen found n he leraure and analyze he evdence presened n he prevous secon. In many cases, we wll look for addonal evdence o oban a beer neracon among heory, facs and polcy mplcaons. We sar by revewng he sudes on nflaonary epsodes ha use he governmen budge consran, as promnenly done by Sargen (1983). We also consder varaons on hese models o capure balance of paymens crses (Krugman, 1978). We hen revew a more recen leraure ha focuses on he maury srucure of he deb as a key o undersand currency and balance of paymens crss (Calvo, 1995 and Cole-Kehoe, 1995). Fnally, we skech heorecal resuls derved from he heory of opmal dynamc conracs wh enforcemen consrans. 3.1 The Economcs of Budge Consrans Sargen (1983) uses a smple budge consran approach o undersand epsodes of nomnal nsably, essenally undersood as nflaonary epsodes. I s worh nong, hough, ha balance of paymen crses and, mos of he me, bankng crses, 1 are assocaed wh nflaon. If we le D be he defc of he governmens n nomnal erms, measured as expendures and ransfers mnus axes, B and M he sock of governmen deb and money, and R he nomnal neres rae, hen he budge consran of he governmen can be wren as (B+1 B) + (M+1 M) = D + BR The rgh-hand sde of he equaon represens he fnancal oblgaons of he governmen n he perod, whle he lef-hand sde represens he wo ways he governmen has o fnance hem: by ssung neres-bearng deb or non-neres-bearng deb. Thus, susaned defcs may no lead o nflaon f he deb s managed o fnance all oblgaons. On he oher hand, f he governmen s unable o borrow for some reason, hen he only source of fnancng s ssung money, and we can herefore assocae defcs wh nomnal nsably. The analyss of Sargen s condonal on here beng a lm on he ably o borrow and, o sar wh, we pursue hs lne here. Then, we wll come back o he ssue of he lm o he deb. In Fgure 7 we plo he yearly defc and he yearly nflaon rae. 2 The sory of Sargen fs he sory qualavely. The hree years of nomnal nsably, 1975, 1985 and 1989 are he 10

11 hree years n whch he defc pcked up. I also seems clear ha he sory has severe problems n he quanave aspec; for nsance, he defcs n 1988 and 1989 are smlar o hose n 1981 and 1981, and he nflaon rae was fve mes hgher. However, he objecve of hs paper s no o accoun for he nomnal nsably; raher, we wan o analyze he poenal role of deb managemen n rggerng or foserng. Thus, a frs approxmaon o he las hry years of nsably n Argenna pons o he neracon beween susaned and posve fscal defcs and he nably o borrow. Ideally, one would lke o know he deermnans of deb lms. The remander of hs secon s an aemp o pon ou possbles usng he Argenne experence. A naural frs sep s o ry o shed some lgh on he relevance of he deb lm n he Argennan case. To pu dfferenly, was he deb lm key n deermnng he evens? Some evdence s provded n Fgure 7, whch depcs he evoluon of he defc for Argenna and Span. 3 Whle her behavor s very dfferen durng he 1970s, hey look more smlar durng he 1980s, he mayor dfference perhaps beng he varance. However, he varance of he defc does no play a crucal role n Sargen s sory. As Span dd no go hrough severe nomnal nsably, appears ha defcs lke hose Argenna had durng he eghes are no enough o generae nsably. Furher evdence s provded n Table 1, where he average and sandard devaon of he defc for Argenna and Span are presened for a 30-year perod. 4 The numbers are repored for wo sub-perods of 15 years each. I s neresng o noe ha he defc numbers for Argenna n he wo sub-perods are very smlar, alhough he nsably s concenraed n he second perod. Noe also ha he defc for Span s subsanally larger n he second subperod, and experenced very lle nsably. 5 Alogeher, hese numbers sugges ha he deb lms mus be playng an mporan role n shapng he relaonshp beween he defc and nomnal nsably. 3.2 The BOP Crss Verson The sory of Sargen can also accommodae balance of paymen crss when counres chose, as Argenna repeaedly dd durng he perod, o fx he nomnal exchange rae. An arculaed 1 A remarkable excepon s he bankng crss of The nflaon rae s defned as ln(p+1=p). 3 The choce of Span s raher arbrary. Several European counres followed smlar paerns. 4 The average and sandard devaons of oupu are also repored for boh counres. 5 A couple of balance of paymen crss developed n Span ha forced devaluaons of he pesea. Relave o he Argennan experence hose are very mnor evens. 11

12 model s provded n Krugman (1979). The sory uses some verson of he Purchasng Power Pary, ha uses arbrage condons for he prce of raded goods n open economes,.e., * P = P. e where P s he domesc prce level, * P s he prce level of he foregn counry o whch he domesc currency s pegged, and e s he nomnal exchange rae. The second key componen of he heory s a verson of a demand for money. We use he quany heory, whch reads M v = P y where v s he velocy of money, assumed consan, and y s he real GDP, deermned n he real secor of he economy. To smplfy, le us assume ha he relevan moneary aggregae s he moneary base. From he balance shee of he Cenral Bank M = R + DC where R s he sock of nernaonal reserves of he Cenral Bank and DC s he sock of domesc cred. The frs equaon deermnes he domesc prce level as long as he nomnal exchange rae s fxed. The second equaon hen deermnes he nomnal quany of money. Thus, he oal amoun of nomnal money canno be ncreased by he Cenral Bank, and any aemp o do so by ncreasng domesc cred wll mply a reducon of he sock of nernaonal reserves. The sory hen goes lke hs. Susaned defcs and he lack of ably o borrow wll force he Cenral Bank o ncrease domesc cred. The ncrease n domesc cred wll force a loss of nernaonal reserves. To he exen ha he defcs are susaned, he nonnegavy resrcon of nernaonal reserves wll evenually be bndng, nducng a balance of paymens crss, a devaluaon and nflaon wll follow. 6 Agan, he nably o borrow s a key componen of he heory. To summarze, a frs glance he defc seems o be he man explanaon of he Argenne crss. Thus, a Sargen ype of sory fs he daa and descrbes he experence. Why should he deb be mporan? Frs, from a heorecal pon of vew, s mporan because 6 The nce ws n Krugman s o make he demand for money o depend on he nomnal neres rae o generae a run agans he domesc currency. 12

13 Sargen s analyss depends on he counry havng reached he cred consran. In he model ha consran s exogenous, so here s no much else o say. The neresng quesons ha arse are, wha does he lm depend on and how s deermned n equlbrum? Second, f we compare he defcs of hs perod wh he defcs of he prevous perods for Argenna, or wh Span, here does no seem o be much of a dfference. The key has o be behnd he lm o he deb. How does a counry reach he lm? A governmen may accumulae defcs for a long me so ha evenually and smoohly reaches he lm; ha s ndeed a possble sory. Where, however, does he deb lm come from? Supposedly, has o do wh he presen value of he maxmum surplus ha he governmen wll be able o generae on all fuure daes. Neher of hese explanaons seems o f he Argenne experence. The evdence we examned on he evoluon of he deb n he lae 1970s suggess ha s no fscal polcy as measured by he defc, bu as measured by he conngen deb varable, ha explans he bg ncrease n he deb. The key change n he 1970s was he lberalzaon of he fnancal secor wh governmen depos nsurance. Ths subsanally ncreased he governmen s conngen deb, as he governmen guaranee represens lables n he even of a bankrupcy. The bankng crss of Argenna n 1980 and 1981 was he even he ransformed he conngen deb no deb. On op of hs, he exchange rae guaranees also represens conngen deb. The devaluaons of he early 1980s furher ncreased he lables of he governmen. There s no connuous approachng of he bound n hs case. 7 Fnally, he deb o GDP fgures before he deb crss were below 40%. Counres wh smlar economc characerscs had no rouble borrowng far hgher shares of her oupu, so s hard o beleve ha 40% represens he presen value of maxmum fuure surpluses. A naural remark a hs pon s ha he relevan concep may no be he presen value of he maxmum possble surpluses, whch reflecs he ably o repay. Raher, may be he maxmum ha he governmen would volunarly pay, whch reflecs wllngness o repay. Our dscusson suggess ha, whle Sargen s sory s enlghenng n several dmensons, here are a leas hree ssues ha deserve furher explanaon n he presen case. Frs, why s here s a deb lm o sar wh? Second, does make a dfference f ha ha lm s arrved a smoohly or by a dscree jump n he deb? To pu dfferenly, should consrans on deb be relaed o he oal amoun n a gven perod or o he ne change of he oal n a gven perod? Thrd, how relevan are 7 Ths feaure wll also be dscussed when we address models wh enforcemen consrans. 13

14 ncenves raher han ably o repay n deermnng cred lms. We address hese feaures below. 3.3 The Maury Problem In he prevous secon we sressed he role ha he conngen deb played n subsanally worsenng he economc and fnancal poson of he governmen. The governmen naonalzed a share of he dollar-denomnaed prvae deb afer he devaluaon and pad an mporan share of he deposs afer he bankng crss. Ths forced he governmen o rase a large amoun of funds n a shor perod of me, so ha he bankng and balance of paymen crss deepened he governmen s fscal crss. Ths facor s sressed by a seres of models ha focus no only on he oal deb of a governmen, bu also on maury srucure, such as Calvo (1995) and Cole and Kehoe (1995). The nuon behnd hese models s he followng. 8 Consder a wo perod economy wh a governmen ha nhers an amoun B of deb. The budge consran wll herefore be s2 B s1 1+ r = 0 where s s he surplus of perod and r s he nernaonal neres rae. Obvously, as he deb s posve, he governmen wll need posve surpluses o pay back. For smplcy, assume away any enforcemen problems. Assume also ha s he maxmum surplus ha he governmen can rase whou provokng a recesson. Fnally, assume ha a recesson means ha n he followng perod no surplus can be rased. Under hese assumpons, f max B s hen he deb can all be pad n he frs perod. Also, he neres can be pad he frs perod and he deb pad back on he second perod. On he oher hand, f B s max max s + 1+ r he deb canno be pad whou avodng a recesson. Thus, he mos neresng case s for nermedae values of he deb max s 14

15 s max < B < s max s max + : 1+ r Assume also ha all he deb s due on he frs perod. In hs case, here are wo equlbra.. The frs equlbrum s characerzed by posve surpluses n he frs perod ha covers he neres paymens and par of he deb, whle a share of he deb s refnanced for he second perod. The surplus of he second perod s enough o pay back all he deb. Along hs equlbrum, all he deb s pad back. The oher equlbrum however, s characerzed by defaul. In hs equlbrum max none of he deb s refnanced, so he governmen s forced o rase a surplus hgher han s. Ths provokes a recesson such ha he governmen n he second perod s unable o rase a surplus, makng raonal he behavor of lenders n no refnancng he deb. Noe ha n hs case he maury of he deb can be managed o kll he second equlbrum. If an amoun equal o s due n he second perod, hen he governmen has auomac refnancng; does no need o rase a surplus larger han he maxmum and avods he recesson. max s Ths sory s very aracve n erms of undersandng wo epsodes n he perod under sudy. Consder frs he years before he deb crss. As we already sressed above, he governmen accumulaed conngen deb hrough he exchange rae and depos nsurance mechansms. The deposs of he fnancal secor were very shor maury, mosly one monh. The foregn exchange rae guaranee sared for debs of over a year and a half bu was rapdly exended o shor-erm lables as well, so a share of hs balou was also shor erm. The model above can be renamed o consder conngen deb. Afer he bank and exchange rae crss, he governmen had o refnance a large amoun of shor-erm deb. A he same me, he maury of he exsng deb n 1982 had an mporan bas owards shor erm. Accordng o Fgure 5, more han 40% of he deb was due whn a year. Thus, he years 1982 and 1983 where years n whch subsanal amouns of lables were due. Readng he evens ha followed as a represenaon of he bad equlbrum of he prevous model s empng. The second epsode s he Bonex plan of January In order o undersand he man forces behnd hs plan, le us go back o Fgure 6, where he fnancng of he governmen hrough he fnancal secor s represened. As we already menoned, afer he defaul he 8 The followng dscusson follows Calvo very closely. 15

16 governmen dd no have access o foregn capal and made exensve use of he fnancal secor. By 1989, almos 90% of he lendng capacy of he bankng secor was fnancng he governmen. Recall ha, due o he nsably of he me, he mos common maury of deposs was one week. Thus, he lables of he cenral bank represened very shor-erm maury deb. A he verge of a sablzaon plan, hs maury overhang can be undersood usng he model descrbed above. The Bonex plan was a swap of maures. I mandaorly changed he deposs of he prvae secor o dollar-denomnaed bonds wh a maury of en years. 9 The model above sugges ha hs may have been a wse way o reduce he probably of arrvng a a bad equlbrum. A fnal word regardng he Bonex plan s n order. The swap nvolved boh maures and denomnaon. In Calvo (1989), an alernave mulple equlbrum model s developed ha may shed some lgh on he ssue. Assume ha here s a governmen ha launches a sablzaon plan and fxes he nomnal exchange rae. For smplcy, assume ha he foregn neres rae s zero, so f expeced devaluaon s zero, he domesc neres rae s zero. Ths governmen wll modfy fscal polcy o generae prmary fscal surpluses, bu here s some uncerany nvolved. Thus, he surplus wll be a real number s 2[ s; S] where s < 0 < S Thus, wh posve probably here wll be defc. Gven he sock of governmen deb, B, he fnancal needs for he governmen wll herefore be B R + s [ s + B R ; S + B R ] 2 Assume also, followng he model dscussed above, ha here s a maxmum M ha he marke s wllng o lend o hs governmen n a gven perod, such ha f he fnancal needs n a gven perod are larger han ha maxmum, he governmen wll have o use nernaonal reserves, a balance of paymens crss wll occur and hen he governmen wll devalue. If he maxmum M s larger han S, hen here s an equlbrum wh R = 0 and no devaluaon. In fac, f expeced devaluaon s zero, hen he probably ha he fnancal needs 9 I s neresng o noe ha he deposs were swapped by Bonex. There were several seres of Bonex crculang n he economy and hese were he bonds ha he governmen had never defauled n he pas. 16

17 are hgher han he maxmum s zero; hus he probably of a devaluaon are zero. On he oher hand, f he expeced devaluaon s posve, hen he nomnal neres rae s posve and, f M s no large enough, he probably ha he fnancal needs exceed he maxmum are posve. Ths convaldaes he negave expecaons of he prvae secor. Therefore, boh feaures of he swap nvolved n he Bonex plan, he maury and denomnaon swaps, may have been key ngredens n he sablzaon acheved durng he eghes. 3.4 Enforcemen Problems In hs subsecon we consder heorecal developmens ha address he ssue of wllngness o pay. Ths feaure s crucal, snce mos governmen deb does no have collaeral. In he absence of commmen, he governmen mus fnd opmal o repay he deb n every perod. The mos common assumpon of he leraure 10 s ha afer defaulng, he agen nvolved does no have access o capal markes. Thus, n every perod, he borrower has o decde eher o pay he deb, and connue o parcpae n he marke, or defaul and lose access o he marke. The resuls depend on parcular assumpons regardng he degree of commmen of he lenders and he alernave opons avalable o he borrower. I s possble, however, o consruc examples n whch an agen ha eners he cred marke (Argenna, for example, opened he economy o he capal markes n he lae 1970s, closed agan, hen reopened n he early 1990s) wll be cred consraned for a whle, n he sense ha here wll be lms o how much he agen can borrow every perod, as a funcon of he prevous record and he realzaon of shocks. I s also he case ha, afer a fne number of perods, he cred consran ceases o be bndng. These models are neresng because hey provde examples where he change n he deb, and no only he oal fgure, s mporan. I also explans why counres wh smlar ncome per capa or oher economc varables may have dfferen cred consrans, he reason beng ha he accumulaed repuaon s dfferen. In hese models, agens buld repuaon over me, so he dae on whch a counry eners he nernaonal capal marke affecs he amouns can borrow. Furhermore, hese models provde a raonale for he dsncon beween emergng and developed markes. Varaons on hese models consder he case n whch he lender canno monor wha he counry does wh he money, and hs s relevan snce 10 Some of he work n hs area ncldes Bulow and Rogoff (1989), Marce and Marmon (1992) and Albuquerque and Hopenhayn (1997). 17

18 affecs he ably o pay back n he fuure. In hs case, may also be opmal o have he borrower cred consran for a whle. In hese se-ups, s neresng o reconsder he lberalzaon of capal markes and fnancal sysems. The experence shows ha lberalzng he fnancal secor subsanally ncreases he conngen deb, and f he shock n whch he governmen has o bal ou acually akes place, hen he need for deb goes dsconnuously hgh, and hs may no be conssen wh he cred consrans of he problem. The dscusson suggess ha a good par of he deb crss may be explaned by he fac ha here was a major breakdown n fnancal secors and a subsanal ncrease n governmens deb, as he conngen even ook place. Thus, he combnaon of an emergng governmen and a lberalzaon of capal flows may be an explosve combnaon, because he emergng governmen wll fnd self lmed on he amoun of cred ha can oban n he marke. The emergng naure of he governmen mples ha wll be cred consraned for a whle. On he oher hand, fnancal lberalzaon subsanally ncreases conngen deb. There seems o be a enson beween openng he counry o foregn capal and early fnancal lberalzaon. 11 Ths leraure s sll n progress and many of s mplcaons are no ye fully undersood. For nsance, wo facors ha have no ye been analyzed n he conex of hese models are he ncenves o bal ou prvae deb and he poenal exernales ha defaul by some agens n he counry affec he cred rang of oher members n he counry. Furher heorecal developmens along hese lnes wll poenally shed addonal lgh on he role capal conrols may play n he early sages of negraon of economes no world capal markes. So far, s oo early o draw conclusons. Bu he dscusson somehow raonalzes he use of he Calvo rao, 12 defned as M2 over Cenral Bank Reserves. The reason o use fnancal secor lables over Cenral Bank foregn asses s because he lables of he bankng secor are conngen lables of he Cenral Bank. We should sress ha hs s a reasonable nerpreaon even f here s no explc depos nsurance. World bankng hsory s full of examples n whch Cenral Banks baled ou lables of he banks, he raonale beng he popular oo bg o fal docrne. In fac, one nerpreaon of he 1995 Mexcan Crss s ha he Cenral Bank baled ou he bad loans of 11 For an early and sharp dscusson, see Díaz-Alejandro (1985). 12 Gullermo Calvo was, accordng o our knowledge, he frs one o use hs ndex as a warnng sgn. 18

19 prvae banks. Ths s he cenral message of Díaz-Alejandro (1983), furher developed by Velasco(1989). I s also he explanaon of he Asan crss suded n Burnsde, Echenbaum and Rebelo (1998). Fgure 8 shows he Calvo rao for Argenna durng he perod consdered. Fgure 9 depcs boh he numeraor and he denomnaor. Fgure 8 s very clear. The fnancal lberalzaon of he lae 1970s was accompaned by a huge ncrease n he Calvo rao. Fgure 9 shows ha he behavor of he rao s explaned by an asonshng ncrease n he lables of he fnancal secor, whch s followed by he reserves of he Cenral Bank durng he frs wo years of he reform, bu changes n behavor a he begnnng of 1980, one year before he devaluaons. On he oher hand, noe ha he expanson of deposs s smlar durng he 1990s, alhough he reserves of he Cenral Bank follow, so he rao does no exhb an upward rend durng he perod. Regardng he curren suaon, s worh emphaszng ha he Cenral Bank of Argenna has a conngen auomac cred lne n case of bank runs ha s no ncluded n he Calvo rao. All he dscusson above suggess ha hs was an excellen decson. Our recen hsory shows ha he lables of he governmen wll ncrease as a resul of ceran evens. Sandard normave economcs suggess nsurng agans hose shocks. Bu normave deb heory s he focus of he nex secon. 4 Opmal Deb Managemen Dynamc heores of deb managemen developed by Barro (1979) and Lucas and Sokey (1983) provde foundaons agans whch o compare deb managemen. A smple example s developed n he Appendx. The man concluson of hose papers and he leraure ha followed, s ha governmen deb should be managed o mnmze he volaly of axes. 13 The man nuon s ha, as long as he dsoronary cos of axes s a convex funcon of he ax rae, he more consan axes are kep, he beer. Thus, permanen changes n governmen expendures have o be fnanced wh axes, whle emporary changes have o be fnanced manly wh deb. Noe ha he smple model of crss and deb maury of he prevous secon was an exreme case of he posve properes of ax smoohng. The assumpon here was ha he governmen was able o fnance a large deb f could do so smoohly over me. In conras, f he governmen were 13 The deja-vu o permanen ncome heory s unavodable 19

20 requred o rase a large surplus n a gven perod, he ably o rase axes n he fuure would be much more lmed. These models are sochasc, so volaly should be nerpreed broadly. Tha s, axes should be consan over me and over saes of naure. Ths mples ha f he governmen acvely rades conngen secures o buy nsurance agans expendure shocks, and does so properly, welfare can be hgher. For nsance, f a governmen runs an unemploymen nsurance program and he man economc acvy of he counry s ol exracon, hen s lkely ha he unemploymen rae wll go up when he prce of ol goes down. Thus, hs parcular componen of governmen expendures wll go up oo. If he governmen does no wan o ncrease axes when he prce of ol goes up, should be buyng secures ha pay off when he prce of ol goes up. 14 Our nerpreaon of he depos nsurance as conngen deb s hus a naural one. Bank runs are evens ha, f realzed, mply an ncrease n governmen expendure, and governmens should hedge agans hem. Ths s no, however, wha he Argenne governmen dd durng he 1970s, and he lessons learned from ha experence may now explan why he Cenral Bank now pays for nsurance o access a cred lne n case of a Bank panc. The heory oulned above suppors hs measure. Noe, however, ha echncally, hs s no nsurance agans he capal loss o he governmen generaed by a bankng crss. In fac, s nsurng only he neres rae n case needs o borrow o fnance he crss. The ably o nsure when here are ncomplee markes s lmed. However, he leraure has shown ha a subsanal amoun of self-nsurance can be acheved hrough he cred marke. 15 In hs conex, obanng nsurance on he neres rae may be a good approxmaon o full nsurance. Agan, n he conex of Calvo s smple model, hs nsurance reduces he surplus he governmen would need o rase n he even of a bankng crss, hereby reducng he chances of a recesson. Ths ssue, he desgn of opmal deb managemen when markes are ncomplee, s he focus of Marce, Sargen and Seppala (1997), and provdes an analycal framework o sudy he behavor of prces of alernave deb nsrumens. A remarkable feaure of he Argenne experence s he paral defaul of he governmen n some of s deb oblgaons. An mporan 14 Maybe he marke porfolo of a counry ha mpors mos of s ol? 15 References go as far as Keynes precauonary savngs. A more recen analyss can be found n Marce, Sargen and Seppala (1997). 20

21 problem n dealng wh hs ssue s he lack of sold heorecal foundaons for analyss. Alhough much remans o be done, a seres of papers have been developed o analyze defaul. For nsance, Calvo and Gudo (1992, 1993) emphasze he role of a flexble moneary polcy n a world wh ncomplee markes. In hese models, he lack of nsrumens o smooh axes across saes of naure provdes moneary polcy wh a paral smoohng role. Imagne ha f, a a pon n me, some componen of governmen expendures s unusually hgh. If as a reacon he governmen loosens moneary polcy, wll be axng real money balances and non-ndexed deb. As he expendure shock was unexpeced, so s he money shock. As a resul, he ax on boh money balances and governmen deb s lump-sum and does no dsor he economy. Obvously, an alernave way o acheve he same resul s o parally defaul on he deb. In he frs case, he defaul s mplc, hrough he real value of he deb, whereas n he second case he defaul s explc for nsance, by no payng he neres due. Ths s a concepually neresng way o look a he deb managemen of Argenna, snce durng he whole perod, he governmen never defauled on he oblgaons of he dfferen seres of Bonex bonds. Thus, s clear ha he governmen explcly aced o provde dfferen rsk characerscs o dfferen deb nsrumens. Techncally, hough, f we resrc aenon o he Bonex, he governmen was never n defaul. On he oher hand, as we already menoned, for long perods of me he governmen faled o fulfll he oblgaons of bank deb. We wan o hnk abou he epsode along he lne of Calvo and Gudo. Wh ncomplee markes, may be effcen o mpose lump-sum axes (defaul) o some deb nsrumens and no ohers. Ths means ha he governmen s n fac ssung deb nsrumens wh dfferen rsk characerscs so can parally complee markes. Obvously, n equlbrum he reurns mus be dfferen; hs feaure of he equlbrum s descrbed n he Appendx, where a smple general equlbrum model s developed. 4.1 On Deb Prces and Fscal Shocks The objecve of hs secon s o use he model descrbed n he Appendx o sudy he behavor of prces, gven he rsk characerscs of he dfferen deb nsrumens dscussed above. Our nerpreaon hen, formally suded n he Appendx, s ha he governmen deal wh wo dfferen ypes of nsrumens: he Bonex, whch s pad n all saes of naure, and he bank deb, 21

22 whch s only pad f governmen expendures are no oo hgh. 16 Noe ha we are no makng any formal dfference 17 beween an explc conngen conrac and mplc defaul, as he only relevan nformaon for he asse-prcng formulas n he model s he rue sochasc srucure of payoffs. 18 Le us hus assume ha he governmen can floa consols n wo dfferen colors, blue and red, and boh promse a real reurn r mos of he me. However, f he expendures are hgh, he red consols defaul on her neres paymens. Thus, we denfy he Bonex wh he blue consols and he bankng deb wh he red consols. I s neresng o recall ha he welfare aaned wh he wo consols s hgher, 19 snce here are more dmensons ha can be spanned hrough he asse marke. A frs apprasal of he model s o look a he behavor of he prces. 20 Accordng o our nerpreaon, he relave prce of he bank deb should be negavely correlaed o posve fscal shocks. 21 As a frs approxmaon, we look a he relaonshp beween he prce of he Bonex relave o bank deb and he nflaon rae. Ths s a varable easy o measure whou error, and we expec o be a good ndcaor of fscal shocks, 22 as large fscal shocks are assocaed wh hgh senorage and nflaon. In Fgure 9, we plo he evoluon of he prces of Bonex 82, Bonex 87 and bankng deb. 23 The Bonex 82 were fully pad n 1992, whch s why we also plo he prces for he 87 seres. The wo mos remarkable feaures of he graph are ha hgh-frequency movemens seem o be more mporan for Bonex prces, whle low-frequency movemens seem o be more mporan for bank deb. To llusrae hese properes n greaer deph, we fler he daa usng he Hodrck and Presco fler. In Fgures 10 o 13 we plo he flered value of he seres for he Bonex 82 and 87 prces, he bank deb prces and he relave prce beween he 16 Gven ha he governmen has conrol on he sochasc process of expendures, poenally serous moral hazard problems may arse. We do no address hese ssues n hs paper. 17 The nerpreaon of defaul as a conngen conrac ha complees markes s no new. See Sanos (1996). 18 Obvously, conracs are mporan o guaranee enforcemen. We are workng under he exreme assumpon ha here s no enforcemen echnology. Modfyng hs would no affec he resuls, we should only replace a zero payoff by he amoun ha could be obaned n case of lgaon, f he lgaon coss are small enough. 19 Techncally, no lower. In general wll be hgher. 20 Gven he smple srucure of he model and he naure of he assumpons, we refran form a formal es. Raher, we propose o nformally look a he behavor of key varables. 21 A formal reamen can be found n he Appendx. 22 Measures of he defc are avalable bu no on a monhly bass. In addon, he quarerly fgures are lkely o be subjec o serous measuremen error due o he nsably of he perod. 23 The Bonex prces we obaned from FIEL. The prces of bankng deb were colleced by he Cenral Bank durng he perod. We hank Jose Lus Maa for provdng hs daa. 22

23 Bonex and he bank deb, n all cases jonly wh he low-frequency movemens of he nflaon rae, our measure of fscal dsress. In all cases, we observe a posve assocaon beween he prce of he asse and he nflaon rae, whch suggess ha our rsk free assumpon for he Bonex s exreme; as nflaon ncreased, he Bonex appeared o he marke as rsker asses. The mos neresng graph s, however, Fgure 13, whch repors he low-frequency movemen of he Bonex prce relave o he bankng deb prce whch, accordng o he heory, should be posvely assocaed wh he nflaon rae. The fgure speaks for self. The fgures wh he hgh-frequency componen dd no exhb any neresng paern, so we do no repor hem. 5 Conclusons Ths paper has provded a survey of deb managemen n Argenna for he roughly 20-year from he mddle of he 1970s o Ths survey was guded by a parcular nerpreaon of a leraure ha relaes fscal polcy, deb managemen and nomnal nsably developed n he las 15 years. The man concluson we draw s ha he key o undersand nomnal nsably evens s he cred lms faced by a governmen. To pu dfferenly, he lack of a deb managemen polcy, because of cred consrans, seems o be he prmary explanaon of nomnal nsably. The followng ls of prelmnary polcy suggesons of our case analyss follows from ha general concluson. Our frs suggeson s ha, a leas n some cases, cred consrans are no necessarly assocaed wh he sock of governmen deb, bu raher he ncrease of deb n gven perods. Ths s n lne wh he leraure ha sresses he maury of he deb. Two man epsodes of he perod under sudy sugges hs. Frs, he huge ncrease of deb n he pre-deb crss years (1980, 1981) are manly explaned by he balous of he bankng secor and he dollar ndebed prvae secor. The sock of deb subsanally ncreased n very shor me. The second even s he 1995 bankng crss. Whle banks were losng deposs, he governmen was severely lmed n s ably o borrow abroad, no because he deb o GDP rao was hgh, bu because he amoun of cred requred o asss he banks n case he crss keep on developng would have been very large. 23

24 The second suggeson has o do wh he ndexaon mechansm. The Argennan governmen heavly used dollar-denomnaed deb raher han deb ndexed o prce. Thus, he value of he deb s oo sensve o real exchange rae changes. If wha maers s how rapdly he deb changes, hs may mpac on he ably o borrow. Ceran polcy measures change dramacally he exposure of he governmen poson under he realzaon of ceran saes. Ths s he case of bank pancs, where he governmen assumes responsbly for banks lables, or he case of oher explc or mplc nsurance schemes offered by he governmen. Noable cases are depos nsurance and exchange rae nsurance. Ths s no o say ha he governmen should refran from offerng hese schemes hese ssues are well beyond he scope of hs paper bu ha should hedge agans hem. For nsance, he conrac recenly agreed upon ha guaranees a cred lne a a low and preesablshed neres rae n case of bankng crss s an excellen example of hs. On he oher hand, o he exen ha a crss n Brazl s lkely o ncrease he neres rae for Argenne loans, he governmen should be nsurng agans ha possbly as well. The hrd suggeson ha follows from our analyss s ha governmens should have ways o dscrmnae rsk characerscs of deb nsrumens. As we dscussed, hs happened durng he eghes. When he nernaonal cred marke was closed, he governmen managed o assocae a senory saus wh he Bonex, a dollar denomnaed bond. In fac, s hs bond ha he governmen used n he depos-deb swap n The message was clear. The governmen was swappng deposs for s bes fnancal asse, makng s sronges possble saemen regardng he commmen o repay ha deb. Ths s mporan o defne he polcy measure as a swap and no as a ax. In fac, he governmen dd no defaul on hs bond. Our fourh suggeson s he relevance of maury. Ths s of course relaed o mporance of he change n he deb n a sngle perod. The mos mporan even relaed o hs fac s he Bonex plan dscussed above. I drascally changed he maury of he ousandng deb, makng he fnancal suaon of he governmen far less prone o an expecaons aack. The curren prospecs for Argenna look promsng, a leas from he pon of vew of he lessons we exrac from he las weny years of experence. The maury srucure s based owards he long erm, and he governmen s nsured parally agans a bankng crss. I s sll he case ha he value of he deb s oo sensve o a real exchange rae apprecaon. However, major flucuaons n he real exchange rae n he pas were he resul of a devaluaon or a 24

25 hypernflaon; now boh, as a resul of bankng crss nsurance and a reasonable maury srucure, are very low probably evens. 25

26 A. Defaulng o Complee Markes The economy nhabed by a large number of dencal agens wh preferences governed by 1 x E = 0 [ u( c ) n 0 where c and n are consumpon and labor effor a ; U s ncreasng and concave and a posve consan. We assume ha s large enough so ha he nonnegavy consrans on lesure are never bndng. There s a echnology o produce prvae and publc goods usng labor c + g = n where g s governmen expendures ha follow some sochasc process. Governmen expendures are he only source of uncerany n he model. ] 26

27 A.1 Ramsey Problem wh Complee Marke The consumer problem s gven by subjec o MaxE 1 [ u( c ) n x 0 = o ] 1 x s = 0 p ( g )[ c (1 ) n ] = 0 s s where p ( g ) s he prce of a un of consumpon n perod gven a hsory g n uns of consumpon of = 0; for k s he deb ssued n perod k ha maures a, and s he k b ncome ax a : We assume ha nal lables of he governmen are zero. Consumer s frs order condons are = 1 8 ;8g 0 u ( c ) s 1/ u ( c ) u ( c ) 0 = p p 0 8 8g s s for all and g. Marke clearng mples ha The Ramsey problem s gven by c + g = n subjec o x MaxE ( 1 0[ u( c ) n ]) 0 = c + g = n for all and s g, and E 1 x 0 0 [ c ( ) = 0 u c n ] = 0 : where hs las resrcon s he sandard mplemenably consran. If he opmal polcy s neror, he soluon mus sasfy he followng necessary condons 0 00 ( 1+,) u ( c ) +, c u ( c ) = 1 s 27

28 ( 1+,) = 1 s s for all and g. Under mld regulary condons, s possble o show ha here s a unque soluon where consumpon s consan over me and saes of naure.lkewse, s rval o show ha axes mus be consan and equal o * = 1 0 u c Le us consder he case n whch governmen expendures are bnomal such ha hey are low wh probably p and hgh wh probably1 * p, ndependen over me. In hs case, s easy o show ha wo ndependen asses complee markes and he asse prcng formula s sraghforward. Assume here are wo fnancal nsrumens. One consol ha pays r uns of he good n all saes, and one ha pays r uns f he expendures are low and r( 1 1 ), d 2[0;1]) f rf c expendures are hgh. d can be nerpreed as he defaul rae. Le V and V be he prces of he rsk free and conngen consols. c V The predcon of he model s ha V rf s decreasng wh he shock. In equlbrum, V should be ndependen of he fscal shock, whle rf mus sasfy lr E ( V 1) lr V = r+ + Gven ha axes wll be consan, so wll he neres rae. Therefore V lr = r 1 1 The conngen consol s prce does depend on he sae of naure, so V c ( g 0 ) = r + [ pv c ( g 0 ) + 1 p) V c ( g 1 )] V c ( g and solvng hese equaons we oban 1 ) = r(1 d) + [ pv c ( g 0 ) + (1 p) V c ( g 1 )] V c ( g 0 ) = r + = (1 )[ pr + (1 p) r(1 d)] 28

29 Therefore, he relave prce follows V c ( 1 g ) = r(1 d) + = (1 )[ pr + (1 p) r(1 d)] c V ( g) lr V = (1 ) + [ pr + (1 p) r(1 d) f r 0 g = g c V ( g) V lr 1 = ( 1 )(1 d) + [ pr + (1 p) r(1 d] f g = g. r 29

30 References Banco Cenral de la Repúblca Argenna Boleín Esadísco del Banco Cenral de la Repúblca Argenna. Buenos Ares, Argenna: Banco Cenral de la Repúblca Argenna. Barro, R On he Deermnaon of Publc Deb. Journal of Polcal Economy. 87 (5): Bekerman, M El mpaco fscal del pago de la deuda exerna: La experenca argenna. Desarrollo Económco. 29 (116). Calvo, G. y Gudo, P Opmal Maury of Nomnal Governmen Deb: An Infne- Horzon Model. Inernaonal Economc Revew. 33 (4): Calvo, G. y Gudo, P On he Flexbly of Moneary Polcy: The Case of he Opmal Inflaon Tax. Revew of Economc Sudes. 60 (3): Fundacón de Invesgacones Económcas Lanoamercanas (FIEL) El gaso públco en Argenna, Indcadores de Coyunura. Buenos Ares, Argenna: FIEL. Gudo, P Deb, Moneary and Bankng Polcy n Emergng Markes: Reflecons from he Tequla Effec. Workng Paper #28. College Park, MD, Uned Saes: Unversy of Maryland, Deparmen of Economcs, Cener for Inernaonal Economcs. Dubey, P., Geanakoplos, J. and Shubk, M Defaul and Effcency n a General Equlbrum Model wh Incomplee Markes. New Haven, Uned Saes: Cowles Foundaon. Mmeographed documen. Lucas, R. and Sokey, N Opmal Fscal and Moneary Polcy n an Economy whou Capal. Journal of Moneary Economcs. 12:

31 Mnsero de Economía y Obras y Servcos Públcos Boleín Fscal del Mnsero de Economía y Obras y Servcos Públcos. Buenos Ares, Argenna: Mnsero de Economía y Obras y Servcos Públcos. Rodrguez, C The Macroeconomc Effecs of Publc Secor Defcs: Argenna. Documenos de Trabajo #76. Buenos Ares, Argenna: Cenro de Esudos Macroeconomcos. Rodrguez, C La Deuda Exerna Argenna. La Plaa, Argenna: Unversdad Naconal de la Plaa, Economcs Deparmen. Mmeographed documen. Sanos, T Fnancal Innovaons wh Endogenous Rsk. Chcago, Uned Saes: Unversy of Chcago. Mmeographed documen. Sargen, T Raonal Expecaons and Inflaon. New York, Uned Saes: Harper and Row. Schenone, O El comporameno del Secor Públco en Argenna. Documeno de Trabajo #60. Buenos Ares, Argenna: CEMA. 31