Abstract
Three alternatives for eliminating U.S. external debt are analysed. Besides a reduction in government spending, attention is paid to the possibility of eliminating debt by inflating the economy and to a financial crisis in case foreign investors lose confidence. The analysis is performed on the base of a two-country model with a portfolio choice between money, domestic and foreign assets which are imperfect substitutes on the one hand and imperfect commodity substitution on the other hand. The model deals with balance of payments dynamics, government debt dynamics, capital accumulation, monetary growth and exchange rate expectations. A simplified version of the model is solved analytically. The full version is applied by working through numerical exercises.
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