Bubbles and Self-Enforcing Debt

46 Pages Posted: 27 Oct 2006 Last revised: 2 Feb 2010

See all articles by Christian Hellwig

Christian Hellwig

University of Toulouse 1 - Toulouse School of Economics (TSE)

Guido Lorenzoni

Northwestern University; National Bureau of Economic Research (NBER)

Date Written: October 2006

Abstract

We characterize equilibria with endogenous debt constraints for a general equilibrium economy with limited commitment in which the only consequence of default is losing the ability to borrow in future periods. First, we show that equilibrium debt limits must satisfy a simple condition that allows agents to exactly roll over existing debt period by period. Second, we provide an equivalence result, whereby the resulting set of equilibrium allocations with self-enforcing private debt is equivalent to the allocations that are sustained with unbacked public debt or rational bubbles; for the latter, there exist well known existence and characterization results. In contrast to the classic result by Bulow and Rogoff (AER 1989), positive levels of debt are sustainable in our environment because the interest rate is sufficiently low to provide repayment incentives.

Suggested Citation

Hellwig, Christian and Lorenzoni, Guido, Bubbles and Self-Enforcing Debt (October 2006). NBER Working Paper No. w12614. Available at SSRN: https://ssrn.com/abstract=938407

Christian Hellwig

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

Guido Lorenzoni (Contact Author)

Northwestern University ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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