Why Might the Old Want to Honor Sovereign Debt?

Survey evidence shows that, in times of high default risk, the old are often relatively in favor of sovereign debt repayment. I characterize the optimal dynamic contract between a country and foreign lenders to account for... [ view full abstract ]

Survey evidence shows that, in times of high default risk, the old are often relatively in favor of sovereign debt repayment. I characterize the optimal dynamic contract between a country and foreign lenders to account for these life-cycle preferences. Efficient allocations under political constraints provide incentives not to default by promising higher future consumption to the current young. Thus, even if the direct cost of being excluded from international capital markets is lower for the elderly, they might be most affected from a default. In production economies positive shocks lead to an increase in investment. The model helps rationalize the observed weak correlations between default and output, and between default and outstanding debt.