Slow Moving Debt Crises
What circumstances or policies leave sovereign borrowers at the mercy of self-fulfilling increases in interest rates? To answer this question, we study the dynamics of debt and interest rates in a model where default is driven by insolvency. Fiscal deficits and surpluses are subject to shocks but influenced by a fiscal policy rule. Whenever possible the government issues debt to meet its current obligations and defaults otherwise. We show that low and high interest rate equilibria may coexist. Higher interest rates, prompted by fears of default, lead to faster debt accumulation, validating default fears. We call such an equilibrium a slow moving crisis, in contrast to rollover crises where investor runs precipitate immediate default. We investigate how the existence of multiple equilibria is affected by the fiscal policy rule, the maturity of debt, and the level of debt.
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References listed on IDEAS
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- Hatchondo, Juan Carlos & Martinez, Leonardo, 2009.
"Long-duration bonds and sovereign defaults,"
Journal of International Economics,
Elsevier, vol. 79(1), pages 117-125, September.
- Juan Carlos Hatchondo & Leonardo Martinez, 2009. "Long-duration bonds and sovereign defaults," Working Paper 08-02, Federal Reserve Bank of Richmond.
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- Henning Bohn, 2005. "The Sustainability of Fiscal Policy in the United States," CESifo Working Paper Series 1446, CESifo Group Munich. Full references (including those not matched with items on IDEAS)
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