THE ROLE OF INSTITUTIONS IN REPUTATION MODELS OF SOVEREIGN DEBT

A standard explanation for why sovereign governments repay their debts is that they must maintain a good reputation to easily borrow more. W e show that the ability of reputation to support debt depends critical ly on the assumptions made about institutions. At one extreme, we assu me that bankers can default on payments they owe to governments. At th e other, we assume that bankers are committed to honoring contracts ma de with governments. We show that if bankers can default, then a gover nment gets enduring benefits from maintaining a good relationship with bankers and its reputation can support a large amount of borrowing. I f, however, bankers must honor their contracts, then a government gets only transient benefits from maintaining a good relationship and its reputation can support zero borrowing.