Seminario CEDE - Juliana Gamboa

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Sovereign borrowing allows governments to finance public capital investment but exposes them and their citizens to default risk, creating an important trade-off for developing countries. Given this trade-off, I analyze the welfare consequences of external sovereign borrowing. Empirically, I document that public investment is positively correlated with private investment, while higher public debt is associated with lower private investment. Motivated by these patterns, I develop a sovereign default model in which the government can borrow externally, allocate resources to public investment, tax, and transfer households. The private sector makes investment decisions while internalizing government policy. The model is calibrated to match the empirical correlations and reproduce the observed response of investment to default. I find that the welfare effects of market access depend on initial capital stocks: economies with low public and private capital gain from borrowing, as high returns to public investment outweigh future default costs, whereas economies with high capital levels experience welfare losses. Finally, I evaluate fiscal rules and show that those encouraging public investment or limiting debt accumulation improve welfare.