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Is a Long War Desirable? Optimal Debt Concessions in Attrition Warfare

The present paper extends the Alesina and Drazen (1991, American Economic Review 81, 1170-1188) war of attrition model by including a concession round. Before the date of stabilization, each player can agree to finance an additional amount of public deficit with the aim of reducing public debt and distortionary taxes. We reveal that concessions reduce the cost of waiting and delay debt stabilization. The amount of concession positively depends on the chances of winning and on the degree of political polarization. When concession and dropping-out plans are chosen sequentially, there is at least one separating equilibria, in which the war of attrition disappears. Our paper provides new perspectives on the inefficiencies of stabilization programs in the aftermath of the recent sovereign debt crisis.

Author - Maxime Menuet
Journal - Annals of Economics and Statistics

Source - https://doi.org/10.15609/annaeconstat2009.139.0105