Rent-seeking, learning and the dynamics of reputation in the international credit market
Most reputation-based models of sovereign debt assume that a default on a loan obligation leads to the imposition of an immediate and permanent credit embargo. The first part of this thesis examines the case in which the length of exclusion is endogenously determined and may consequently be finite or infinite. In this way, lulls in activity followed by enthusiastic lending in the international credit market can be modelled. Additionally, examining the optimal exclusion strategy of the creditor allows investigation of the consequences of `excusing' default. By not punishing a defaulter immediately, it is more likely that a complete loan embargo will be imposed in the future. The effect of excusing default on the expected value of the credit relationship to the country is also examined. A negative externality can arise in the relationship between a sovereign borrower and a creditor due to the existence of countries which repeatedly default on their debt: a default by one country may make the creditor more cautious in lending to others. The effects of this externality are examined in a dynamic model in which the bank does not know the type of customer it faces, but can learn its identity over time. The equilibrium actions of the players then depend crucially on the borrower's reputation for creditworthiness. Even a country which is not an inherent defaulter may be tempted to repudiate its debt obligations with this type of incomplete information structure. Each successive default causes reputation to fall until a critical level is surpassed, at which point a permanent lending embargo is imposed. In this dynamic model of debtor reputation, borrowers face an additional problem as they do not always possess the funds needed to make a repayment and thus reveal their type. In recognizing that borrowing countries can be different by nature, the final part of this thesis examines an economy which is driven to borrow externally as an endogenous outcome of a political system in which interest groups lobby political parties. The amount of borrowing is shown to depend upon the number of redistributive policies the parties can use and the attitude of the voters to external borrowing. A proposal is put forward for linking debt forgiveness in this type of lobbying economy to the level of rent-seeking carried out by the interest groups. lt is demonstrated that this proposal is capable of improving the well being of the ordinary citizens of the economy who share the repayment cost but may not enjoy the benefits of external borrowing.