The Micro-foundations of Debt Crises

ongoing

This project takes a new bottom-up approach to understanding the political roots of government debt crises. It proposes that in order to understand why governments borrow excessively and experience crises, we must first understand what citizens are thinking (or not thinking) about debt policy. Citizens’ preferences are the cornerstone of political theories because they inform policymakers’ incentives. Yet, no studies have systematically examined why citizens in some countries are willing to take steps before a crisis to reduce government debt while others ignore warnings and reward political inaction. This proposal pursues two successive objectives. First, the project will conduct the first comprehensive analysis of individual-level preferences for debt reduction before a crisis. It will develop and test multiple hypotheses that seek to explain which elements of society are (un)supportive of debt reduction policies, what rational or irrational factors motivate their decisions, and how stable these preferences are to manipulation by elites. The analysis centers around original and innovative multi-country survey experiments that elicit the character and stability of preferences for debt reduction. The project’s second phase uses these insights to connect the micro to the macro. By understanding which groups of citizens are motivated by which material factors or cognitive biases, we will develop new theories explaining how the distribution of these groups, and their interaction with institutions, influence political decisions and ultimately affect the risk of sovereign debt crises. This analysis will include two empirical innovations. First, it will include the first ever survey experiment conducted on actual bond traders to determine which country political and economic factors are most important in assessing credit risk. Second, it will produce a new data set of government attempts to engage in debt reduction.