Credible Commitments and Public Borrowing in Nineteenth-Century Argentina

Abstract

This paper examines the role of constitutions in establishing credibility, and the role of political stability in enhancing it. I focus on the effect of limited government on the risk premium of Argentine government debt traded in London and Buenos Aires in the nineteenth century. During the period between 1820 and 1859, the absence of constitutional limitations was associated with credit rationing, short-term borrowing, and the use of money creation to finance public deficits. In contrast, after the adoption of a liberal constitution in 1860, there was a substantial reduction in the cost of borrowing and Argentina's debt capacity increased substantially. Despite these overall trends, the Argentine experience suggests that the establishment of a limited government did not fully resolve the problem of government credibility. Additional conditions, such as political and monetary stability, were further required to reduce the perceived risk associated with government bonds. These findings validate and support the view that constitutional checks and balances are a necessary but not a sufficient condition for sound public finance.