The Political Economy of Debt Moratoria, Bailouts and Bankruptcy

This paper develops a simple dynamic general equilibrium model of an agricultural economy, in which poor farmers borrow wheat from rich farmers to invest on their land. Because wheat output is stochastic (we allow for both idiosyncratic and aggregate shocks), there may be default ex-post. We compare equilibria in this economy with and without political intervention. Intervention is decided through majority voting and can take the form of a bailout or a moratorium. The results of our formal analysis are confronted with historical evidence from the Panic of 1819 in the United States. With no aggregate uncertainty, the main results of the formal analysis are that allowing for debt moratoria and bailouts not only always improves ex-post efficiency but may improve ex-ante efficiency. Anticipated bailouts always occur in equilibrium and moratoria never occur, but the threat of moratoria enhances efficiency. With aggregate uncertainty, the differences between moratoria and bailouts may collapse, with both occurring only in bad times and with both improving ex-ante efficiency. Acknowledgement An earlier version of this paper was presented at the Final Seminar of the IADB & OECD Project “Institutional Arrangements to Ensure Willingness to Repay in Financial Markets: A Comparative Analysis of Latin America and Europe”, Buenos Aires, Argentina, October 26-27, 1998. We thank participants in seminars at Caltech and the Center for Advanced Study for comments, Susanne Lohmann for extensive comments on an earlier draft, Keith Poole for directing us to some of the literature on the history of bankruptcy, Kelly Chang and Dov Rothman for research assistance, and Kathleen Much for superb editing.