Debt Crises, Fast and Slow

49 Pages Posted: 16 Jun 2020

See all articles by Giancarlo Corsetti

Giancarlo Corsetti

University of Cambridge; University of Rome III - Department of Economics; Centre for Economic Policy Research (CEPR)

Seung Hyun Maeng

affiliation not provided to SSRN

Date Written: June 2020

Abstract

With the Covid-19 pandemic, public debt around the world is rising to unprecedented heights in peacetime. We revisit the mechanisms by which, driven by self-fulfilling expectations, both slow-moving and rollover (fast) crises are pervasive at intermediate and high levels of debt, respectively. In both strategic-default and debt-limit models, belief-driven shifts in market assessment of risk translate into shifts of the market debt tolerance thresholds---to such an extent that sovereigns may lose market access even if they were able to borrow risk free in a "good equilibrium". Long debt maturities may/may not shield countries from this adverse scenario. In a sunspot equilibrium, the threat of belief-driven crises may not be enough for the government to deleverage in a recession, and bring debt to default-free levels. Unless the initial debt is close enough to the critical threshold above which the country becomes vulnerable to such crises, the government will keep borrowing, gambling on economic recovery in the future.

Keywords: debt sustainability, Expectations, Self-fulfilling Crises, sovereign default

JEL Classification: E43, E62, H50, H63

Suggested Citation

Corsetti, Giancarlo and Maeng, Seung Hyun, Debt Crises, Fast and Slow (June 2020). CEPR Discussion Paper No. DP14868, Available at SSRN: https://ssrn.com/abstract=3628189

Giancarlo Corsetti (Contact Author)

University of Cambridge ( email )

University of Rome III - Department of Economics ( email )

via Ostiense 139
Rome, 00154
Italy
+39 06 5737 4056 (Phone)
+39 06 5737 4093 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Seung Hyun Maeng

affiliation not provided to SSRN

No Address Available

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