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posted on 18 December 2016

What We Learn From A Sovereign Debt Restructuring In France In 1721

from the Chicago Fed

-- this post authored by Francois R. Velde

A debt is a promise to perform a certain action (make a payment) in the future. A default is a failure to perform the action when the time comes to do so. If performance of the action were always in my interest, the promise to perform it would be superfluous. When we promise to do something, it is precisely because we may well not want to do it.

Debt usually takes the form of a contract, which courts can enforce. But sovereign debt (debt issued by governments) is harder to enforce, because governments aren’t easily constrained by courts. How can sovereign governments make promises and be believed?

Governments routinely issue debt; yet defaults have a long history and remain highly topical. In June 2015, Greece failed to make a $1.6 billion repayment to the International Monetary Fund; and in June 2016, Puerto Rico sought the U.S. government’s help in managing $72 billion in public debt that the territory’s government could not repay. For economists, the central question remains: “What motivates sovereigns to repay, and why do investors ever lend to them?" (Tomz and Wright, 2013). To answer these questions, we need to understand the alternatives to repayment, namely, the costs of defaults.

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