TY  - JOUR
AU  - Aguiar,Mark
AU  - Amador,Manuel
AU  - Gopinath,Gita
TI  - Investment Cycles and Sovereign Debt Overhang
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 13353
PY  - 2007
Y2  - August 2007
UR  - http://www.nber.org/papers/w13353
L1  - http://www.nber.org/papers/w13353.pdf
N1  - Author contact info:
Mark A. Aguiar
Department of Economics
Princeton University
Fisher Hall
Princeton, NJ 08544-1021
E-Mail: mark@markaguiar.com

Manuel Amador
Stanford University
Department of Economics
Landau Economics Building
579 Serra Mall, Room 330
Stanford , CA 94305-6072
Tel: 650/725-5257
E-Mail: amador@stanford.edu

Gita Gopinath
Department of Economics
Harvard University
1875 Cambridge Street
Littauer 206
Cambridge, MA 02138
Tel: 617/495-8161
Fax: 617/495-7730
E-Mail: gopinath@harvard.edu
AB  - We characterize optimal taxation of foreign capital and optimal sovereign debt policy in a small open economy where the government cannot commit to policy and seeks to insure a risk averse domestic constituency.  The expected tax on capital is shown to vary with the state of the economy, generating cyclicality in investment and debt in an environment where the first best capital stock is a constant. The government's lack of commitment induces a negative correlation between investment and the stock of government debt, a "debt overhang'' effect.  If the government discounts the future at a rate higher than the market, then capital oscillates indefinitely at a level strictly below the first best.  Debt relief is never Pareto improving and cannot affect the long-run level of investment.  Further, restricting the government to a balanced budget can eliminate the cyclical distortion of investment.
ER  -