Slow Moving Debt Crises

33 Pages Posted: 27 Jul 2013

See all articles by Guido Lorenzoni

Guido Lorenzoni

Northwestern University; National Bureau of Economic Research (NBER)

Iván Werning

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: June 30, 2013

Abstract

What circumstances or policies leave sovereign borrowers at the mercy of self-fulfilling increases in interest rates? To answer this question, we study the dynamics of debt and interest rates in a model where default is driven by insolvency. Fiscal deficits and surpluses are subject to shocks but influenced by a fiscal policy rule. Whenever possible the government issues debt to meet its current obligations and defaults otherwise. We show that low and high interest rate equilibria may coexist. Higher interest rates, prompted by fears of default, lead to faster debt accumulation, validating default fears. We call such an equilibrium a slow moving crisis, in contrast to rollover crises where investor runs precipitate immediate default. We investigate how the existence of multiple equilibria is affected by the fiscal policy rule, the maturity of debt, and the level of debt.

Keywords: debt crises, multiplicity, self-fulfilling crisis, sovereign debt

JEL Classification: E6, F3, F34

Suggested Citation

Lorenzoni, Guido and Werning, Ivan, Slow Moving Debt Crises (June 30, 2013). MIT Department of Economics Working Paper No. 13-18, Available at SSRN: https://ssrn.com/abstract=2298813 or http://dx.doi.org/10.2139/ssrn.2298813

Guido Lorenzoni

Northwestern University ( email )

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Ivan Werning (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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HOME PAGE: http://econ-www.mit.edu/faculty/iwerning

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