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Bubbles and Self-enforcing Debt

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  • Christian Hellwig
  • Guido Lorenzoni

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.

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Paper provided by UCLA Department of Economics in its series Levine's Bibliography with number 321307000000000383.

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Date of creation: 18 Sep 2006
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Handle: RePEc:cla:levrem:321307000000000383

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