Credit Markets, Limited Commitment, and Government Debt
FRB of St. Louis Working Paper No. 2014-010A
41 Pages Posted: 30 Mar 2014
Date Written: February 24, 2014
A dynamic model with credit under limited commitment is constructed, in which limited memory can weaken the effects of punishment for default. This creates an endogenous role for government debt in credit markets, and the economy can be non-Ricardian. Default can occur in equilibrium, and government debt essentially plays a role as collateral and thus improves borrowers’ incentives. The provision of government debt acts to discourage default, whether default occurs in equilibrium or not.
Keywords: credit, government debt, limited commitment
JEL Classification: E4, E5, E6
Suggested Citation: Suggested Citation