Staff Report 209

Reputation Spillover Across Relationships: Reviving Reputation Models of Debt

Patrick J. Kehoe | Stanford University, University College London, Federal Reserve Bank of Minneapolis
Harold L. Cole

Published March 1, 1996

A traditional explanation for why sovereign governments repay debts is that they want to keep good reputations so they can easily borrow more. Bulow and Rogoff show that this argument is invalid under two conditions: (i) there is a single debt relationship, and (ii) regardless of their past actions, governments can earn the (possibly state-contingent) market rate of return by saving abroad. Bulow and Rogoff conjecture that, even under condition (ii), in more general reputation models with multiple relationships and spillover across them, reputation may support debt. This paper shows what is needed for this conjecture to be true.

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