Theoretical Issues in International Borrowing
By Jeffrey Sachs
NBER Working Paper 1189
The current crisis in international lending points up a lesson re-learned several times in the past 150 years: the international loan markets function very differently from the textbook model of competitive lending. This paper discusses various extensions of the basic model. First, we amend the textbook model to show how limitations on a government's taxing authority may greatly affect its optimal borrowing strategy. Second, we explore the implications of a debt or country's option to repudiate debt. Third, we show that efficient lending may require collective actions by bank syndicates, and that a breakdown in collective action can result in serious in efficiencies and even financial panics.