DEVELOPING COUNTRY BORROWING FROM A MONOPOLISTIC LENDER: STRATEGIC INTERACTIONS AND ENDOGENOUS LEADERSHIP*

We develop a two‐period model with endogenous investment and credit flows. Credit is subject to quantitative restrictions. With an exogenous restriction, we analyse the welfare effects of a temporary consumption tax. We then consider three scenarios under which a monopoly lender optimally decides the level of credit and a borrower country chooses a consumption tax: one in which the two parties act simultaneously and two scenarios where one of them is a Stackleberg leader. The equilibrium under the leadership of the borrower country is Pareto superior to the simultaneous move equilibrium but may or may not be to that under the leadership of the lender. If the sequence of moves is itself chosen strategically, leadership by the borrower emerges as the unique equilibrium.