Slow Moving Debt Crises
American Economic Review
vol. 109,
no. 9, September 2019
(pp. 3229-63)
Abstract
We study slow moving debt crises: self-fulfilling equilibria in which high interest rates, due to the fear of a future default, lead to a gradual but faster accumulation of debt, ultimately validating investors' fear. We show that slow moving crises arise in a variety of settings, both when fiscal policy follows a given rule and when it is chosen by an optimizing government. A key assumption, in all these settings, is that the borrowing government cannot commit to issue a fixed amount of bonds in a given period. We discuss how multiplicity is avoided for low debt levels, for sufficiently responsive fiscal policy rules, and for long enough debt maturities. When the equilibrium is unique, debt dynamics are characterized by a tipping point, below which debt falls and stabilizes and above which debt and default rates grow.Citation
Lorenzoni, Guido, and Iván Werning. 2019. "Slow Moving Debt Crises." American Economic Review, 109 (9): 3229-63. DOI: 10.1257/aer.20141766Additional Materials
JEL Classification
- E43 Interest Rates: Determination, Term Structure, and Effects
- E62 Fiscal Policy
- H50 National Government Expenditures and Related Policies: General
- H63 National Debt; Debt Management; Sovereign Debt