The political process in the United States appears to be highly polarized: Data show that the political positions of legislators have diverged substantially, while the largest campaign contributions come from the most extreme donor groups and are directed to the most extreme candidates.Is the rise in campaign contributions the cause of the growing political polarization?In this paper, we show that, in standard models of campaign contributions and electoral competition, a free-rider problem among potential contributors leads naturally to polarization of campaign contributors but without any polarization in candidates' policy positions.However, we go on to show that a modest departure from standard assumptions -allowing candidates to directly value campaign contributions (because of "ego rents" or because lax auditing allows them to misappropriate some of these funds) -delivers the ability of campaign contributions to cause policy divergence.Consistent with the model, we document that a candidate's share of contributions in U.S. House of Representatives races is higher when her opponent's agenda is more extreme.

This paper quantifies the positive and normative effects of capital controls on international economic activity under The Bretton Woods international financial system. We develop a three region world economic model consisting of the U.S., Western Europe, and the Rest of the World. The model allows us to quantify the impact of these controls through an open economy general equilibrium capital flows accounting framework. We find these controls had large effects. Counterfactuals show that world output would have been 6% larger had the controls not been implemented. We show that the controls led to much higher welfare for the rest of the world, moderately higher welfare for Europe, but much lower welfare for the U.S. We interpret the large U.S. welfare loss as an estimate of the implicit value to the U.S. of preventing capital flight from other countries and thus promoting economic and political stability in ally and developing countries.

This paper quantifies the positive and normative effects of capital controls on international economic activity under The Bretton Woods international financial system. We develop a threeregion world economic model consisting of the U.S., Western Europe, and the Rest of the World. The model allows us to quantify the impact of these controls through an open economy general equilibrium capital flows accounting framework. We find these controls had large effects. Counterfactuals show that world output would have been 6% larger had the controls not been implemented. We show that the controls led to much higher welfare for the rest of the world, moderately higher welfare for Europe, but much lower welfare for the U.S. We interpret the large U.S. welfare loss as an estimate of the implicit value to the U.S. of preventing capital flight from other countries and thus promoting economic and political stability in ally and developing countries.

Recent work has found that countries with older populations face steeper yield curves and issue shorter maturity debt than do younger countries. We reexamine these findings using a new database of public debt maturity and yields for OECD countries. We first show that the behavior of eurozone countries in the pre-euro period drives these results. Next, including more recent data from the post-euro period, we show that the relationship between population age, maturity, and yield curve slopes disappears. This finding is robust to excluding high-credit-risk countries. Last, we show that these patterns reemerge after the European debt crisis, suggesting that eurozone capital markets have resegmented.

We present a model of asymmetric information and sovereign default in which lenders infer persistent, hidden sovereign types from both borrowing and default behavior. Sovereigns come in two persistent types with different proclivities to default and borrow. Transitory liquidity shocks obscure perfect revelation. While the equilibrium exhibits separation along both the default and the borrowing margin, it also features a strong attenuation effect: The bad type receives better prices than he otherwise would, which induces him to repay more often. The reverse is true for the good type. This attenuation in default behavior implies that equilibrium beliefs, while quite volatile, matter very little for price dynamics, a phenomenon we refer to as the ‘Macbeth effect.’ This removes the bad type’s incentive to “mimic” the good type. As a result the good type fully reveals himself via consolidation and deleverageing about 12.8% of the time.

1:00 p.m.2:15 p.m. Sovereign Debt and Credit Default Swaps Gaston Chaumont, University of Rochester; Grey Gordon, Federal Reserve Bank of Richmond; Bruno Sultanum, Federal Reserve Bank of Richmond; Elliot Tobin, Harvard Business School Presenter: Gaston Chaumont, University of Rochester Discussants: Juliana Salomao, Carlson School of Management, University of Minnesota; Juan Passadore, World Bank Group

The Bretton Woods international financial system, which was in place from roughly 1949 to 1973, is the most significant modern policy experiment to attempt to simultaneously manage international payments, international capital flows, and international currency values. This paper uses an international macroeconomic accounting methodology to study the Bretton Woods system and finds that it: (1) significantly distorted both international and domestic capital markets and hence the accumulation and allocation of capital; (2) significantly slowed the reconstruction of Europe, albeit while limiting the indebtedness of European countries. Our results also provide support for the utility of the accounting methodology in that it finds a sharp change in the behavior of domestic and international capital market wedges that coincides with the breakdown of the system.

Negotiations to restructure sovereign debt are time consuming, taking almost a decade on average to resolve. In this paper, we analyse a class of widely used complete information models of delays in sovereign debt restructuring and show that, despite superficial similarities, there are major differences across models in the driving force for equilibrium delay, the circumstances in which delay occurs and the efficiency of the debt restructuring process. We focus on three key assumptions. First, if delay has a permanent effect on economic activity in the defaulting country, equilibrium delay often occurs; this delay can sometimes be socially efficient. Second, prohibiting debt issuance as part of a settlement makes delay less likely to occur in equilibrium. Third, when debt issuance is not fully state contingent, delay can arise because of the risk that the sovereign will default on any debt issued as part of the settlement.

Sovereign governments owe debt to many foreign creditors and can choose which creditors to favor when making payments.This paper documents the de facto seniority structure of sovereign debt using new data on defaults (missed payments or arrears) and creditor losses in debt restructuring (haircuts).We overturn conventional wisdom by showing that official bilateral (government-to-government) debt is junior, or at least not senior, to private sovereign debt such as bank loans and bonds.Private creditors are typically paid first and lose less than bilateral official creditors.We confirm that multilateral institutions such as the IMF and World Bank are senior creditors.

After World War II, international capital flowed into slow-growing Latin America rather than fast-growing Asia. This is surprising as, everything else equal, fast growth should imply high capital returns. This paper develops a capital flow accounting framework to quantify the role of different factor market distortions in producing these patterns. Surprisingly, we find that distortions in labor markets, rather than domestic or international capital markets, account for the bulk of these flows. Labor market distortions that indirectly depress investment incentives by lowering equilibrium labor supply explain two-thirds of observed flows, while improvement in these distortions over time accounts for much of Asia's rapid growth.

Venezuela’s incipient sovereign debt restructuring is likely to be difficult for a number of legal and diplomatic reasons. This article discusses three additional economic issues that will influence the success of any restructuring operation. First, we show that Venezuela’s total debt liabilities are not transparent and present evidence suggesting that available measures may be misleading as an indicator of the total debt-servicing cost. Second, we calculate that there are significant gains to re-profiling Venezuela’s debt and note that it is feasible for these gains to be realized if official debts are restructured in accordance with past practices. Third, we review data on Venezuela’s oil wealth and argue that it could be either a help or a hindrance to a successful debt restructuring. TOPICS:Fixed income and structured finance, emerging, financial crises and financial market history

Consider a sovereign who must obtain agreement with all creditors in order to realize a gain from re-entering world capital markets. A simple game of settlement is developed to reflect strategic interaction between creditors in this environment. Payoffs to creditors depend only on the rank-order in which they settle and the solution concept is Markov-perfect equilibrium. This generates an extremely simple and tractable solution under which delay depends a comparison between the immediate payoff and the average over payoffs going forward. The solution can generate sequences of cascade and delay observed in practice. Comparative dynamics, the effect of increasing the number of creditors and the impact on delay of secondary markets are analyzed. We derive the empirical distribution of delay implied by the model for comparison to the observed distribution of delays in the data. Finally, we derive predictions for the time path of settlements within a given sovereign debt restructuring as a function of the motives for creditors to holdout, and compare these predictions with data on the ongoing negotiations to restructure Argentina’s debts.

This paper develops a tractable human capital model with limited enforceability of contracts. The model economy is populated by a large number of long-lived, risk-averse households with homothetic preferences who can invest in risk-free physical capital and risky human capital. Households have access to a complete set of credit and insurance contracts, but their ability to use the available financial instruments is limited by the possibility of default (limited contract enforcement). We provide a convenient equilibrium characterization that facilitates the computation of recursive equilibria substantially. We use a calibrated version of the model with stochastically aging households divided into 9 age groups. Younger households have higher expected human capital returns than older households. According to the baseline calibration, for young households less than half of human capital risk is insured and the welfare losses due to the lack of insurance range from 3 percent of lifetime consumption (age 40) to 7 percent of lifetime consumption (age 23). Realistic variations in the model parameters have non-negligible effects on equilibrium insurance and welfare, but the result that young households are severely underinsured is robust to such variations.

Little is known about the comparative quantitative importance of international versus domestic market imperfections on international capital flows.

tandard economic theory predicts that people should invest more in countries with the highest capital productivity and economic growth.However, this doesn't always happen.Perhaps the most striking example is the contrast between capital flows into post-World War II Latin America and East Asia.Figure 1 shows trade flows (capital flows) as a percentage of gross domestic product (GDP) for these two regions. 1 Very little investment flowed into East Asia after World War II (especially between 1950 and 1980), even though the region's economic growth (Figure 2) and capital productivity were very high.In contrast, considerable capital flowed into Latin America during this period, despite the fact that neither its capital productivity nor its economic growth (Figure 3) was high.In fact, Latin American economic growth substantially lagged behind the economic growth of virtually all other countries in Western and Northern Europe, the Asian Tigers, and North America during this period.There are two very different interpretations of this pattern of international capital flows.One is that international capital market imperfections, including capital controls, 2

The U.S. government is often referred to as the world’s biggest debtor. But how much debt does it owe? A visit to the website of the U.S. Department of the Treasury yields a bewildering array of different measures of U.S. federal government debt. Although the gross debt of the U.S. federal government is approaching $18 trillion, the debt that is subject to the debt limit is a few billion dollars smaller, while debt in the hands of the public is less than $13 trillion.

We use data from the Survey of Consumer Finance and Survey of Income Program Participation to show that young households with children are under-insured against the risk that an adult member of the household dies. We develop a tractable macroeconomic model with human capital risk, age-dependent returns to human capital investment, and endogenous borrowing constraints due to the limited pledgeability of human capital (limited contract enforcement). We show analytically that, consistent with the life insurance data, in equilibrium young households are borrowing constrained and under-insured against human capital risk. A calibrated version of the model can quantitatively account for the life-cycle variation of life-insurance holdings, financial wealth, earnings, and consumption inequality observed in the US data. Our analysis implies that a reform that makes consumer bankruptcy more costly, like the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, leads to a substantial increase in the volume of both credit and insurance.

In this note, we apply our same measurement techniques to the debts of Greece, Ireland and Portugal and show that plausible alternative measures of indebtedness suggest that Greece is anywhere from as much as 50% more indebted, to as little as half as indebted as either Portugal or Ireland. We argue that most reasonable measures imply that Greece is far less indebted than is commonly reported, and that indebtedness levels across these three economies are roughly similar.

Theory predicts that capital should flow to countries where economic growth and the return to capital is highest. However, in the post-World War II period, per-capita GDP grew almost three times faster in East Asia than in Latin America, yet capital flowed in greater quantities into Latin America. In this paper we propose a 3-country 2-sector growth model, augmented by 'wedges' to quantify and evaluate the importance of international capital market imperfections versus domestic imperfections in explaining this anomalous behavior of capital flows. We find that during the 1950's capital controls where important, but domestic conditions dominate. And contrary to what has been thought, after 1960 capital controls in Asia encouraged borrowing.

In this comment, we take a helicopter tour of the history of notions of “equality” and “justice” in sovereign debt restructuring in particular, and in the division of property more generally, and show that these concerns have existed for centuries, if not millennia. We argue that the issue at stake in the interpretation of the pari passu clause is not so much the treatment of holders of identical claims — it is now customary to treat them identically — but whether the holders of different claims should be treated differently. We show that exists a customary “principle of differentiation” that allows creditors with claims that differ in specific ways to be treated preferentially. One of these specific differences concerns debts that have been reduced in value during a previous debt restructuring or default, and based on this principle we conclude that the New York court has, if not completely misinterpreted the meaning of the pari passu clause clause, then at least misapplied it.