European capital markets show increasing concern about the extent
of sovereign debts and their sustainability. Here we explore some
insights that the Overlapping Generations (OLG) framework has to
er on such issues. The OLG framework implies, for example, that
there is a limit to the amount of debt that may be sustained in a
closed economy | with high debt raising interest rates and crowding
out capital formation. But capital market integration with less
indebted partners allows for a fall in interest rates as a result of borrowing
from one's neighbour. Indeed we nd that | in equilibrium
| most of the debt of a high indebted country will be transferred to
partner countries.
Rather like ECB discount policy, our formal analysis is conducted
without taking sovereign default risk properly into account, however.
We go on to discuss three possible sources of default risk | creditor
panic, exogenous interest rate shocks and \over-borrowing" | and we
emphasize the need for comparative statics to be complemented by
disequilibrium dynamics
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