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Dynamic Panics: Theory and Application to the Eurozone

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  • Stangebye, Zachary

Abstract

It is shown in a standard quantitative model of sovereign debt and default that sentiment shocks can alter the distribution of fundamental defaults. The channel through which this occurs is a new type of dynamic lender coordination problem in sovereign debt markets that I call a dynamic panic. During a dynamic panic of this kind, expectations of future negative investor sentiments dilute the price of long-term debt; the sovereign's optimal response to such a panic can be to borrow aggressively, which justifies investors' fears of dilution. Such panics generate naturally many of the unique features the recent Eurozone crisis, and so I explore policy implications in this environment. I find that rate ceilings are an ineffective policy tool but that liquidity provision, appropriately implemented, can eliminate such panics.

Suggested Citation

  • Stangebye, Zachary, 2015. "Dynamic Panics: Theory and Application to the Eurozone," MPRA Paper 69967, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:69967
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    References listed on IDEAS

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    Cited by:

    1. Aguiar, M. & Chatterjee, S. & Cole, H. & Stangebye, Z., 2016. "Quantitative Models of Sovereign Debt Crises," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 1697-1755, Elsevier.
    2. Alessandro Dovis & Luigi Bocola, 2015. "Indeterminacy in Sovereign Debt Markets: An Empirical Investigation," 2015 Meeting Papers 694, Society for Economic Dynamics.
    3. Mark Aguiar & Manuel Amador, 2020. "Self-Fulfilling Debt Dilution: Maturity and Multiplicity in Debt Models," American Economic Review, American Economic Association, vol. 110(9), pages 2783-2818, September.
    4. Luigi Bocola & Alessandro Dovis, 2019. "Self-Fulfilling Debt Crises: A Quantitative Analysis," American Economic Review, American Economic Association, vol. 109(12), pages 4343-4377, December.
    5. Zachary Stangebye, 2016. "Lifetime-Laffer Curves and the Eurozone Crisis," 2016 Meeting Papers 63, Society for Economic Dynamics.
    6. Stangebye, Zachary R., 2020. "Beliefs and long-maturity sovereign debt," Journal of International Economics, Elsevier, vol. 127(C).

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    More about this item

    Keywords

    Sovereign Debt Crises; Confidence-Driven Crises; Long-Term Debt;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G01 - Financial Economics - - General - - - Financial Crises
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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