Models of Sovereign Debt: Partial vs. General Reputations

Bulow and Rogoff (1989b) show that as long as governments can earn the market rate of return by saving abroad, standard reputation models cannot support debt. We argue that these standard reputation models are partial in the sense that actions of agents in one arena affect reputation in that arena only. We develop a general model of reputation in which if a government is viewed as untrustworthy in one relationship, this government will be viewed as untrustworthy in other relationships. We show that our general model of reputation can support large amounts of debt. *Cole, Federal Reserve Bank of Minneapolis; Kehoe, Federal Reserve Bank of Minneapolis and University of Minnesota. Kehoe thanks the National Science Foundation and the Ronald S. Lauder Foundation for research support. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.