In the two-period model with default

Question

Quizplus · Accepted Answer

In the two-period model with default, a country has a limited commitment problem because it has an incentive to default on its debts in the second period in order to gain a better bargaining position in renegotiations with lenders. This is due to the asymmetry of information between the country and lenders, which makes it difficult for lenders to verify if the country is genuinely unable to pay or if it is strategically defaulting. Therefore, the country's limited commitment to repay its debts creates the risk of default.

In the Two-Period Model with Default