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Bubbles and Self-enforcing Debt

  • Christian Hellwig
  • Guido Lorenzoni

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. In contrast to the classic result by Bulow and Rogoff (1989a), positive levels of debt are sustainable in our environment because the interest rate is sufficiently low to provide repayment incentives. Copyright 2009 The Econometric Society.

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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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  1. Manuel Amador, 2004. "A Political Model Sovereign Debt Repayment," 2004 Meeting Papers 762, Society for Economic Dynamics.
  2. Scheinkman, Jose A & Weiss, Laurence, 1986. "Borrowing Constraints and Aggregate Economic Activity," Econometrica, Econometric Society, vol. 54(1), pages 23-45, January.
  3. Bulow, Jeremy & Rogoff, Kenneth, 1989. "A Constant Recontracting Model of Sovereign Debt," Journal of Political Economy, University of Chicago Press, vol. 97(1), pages 155-78, February.
  4. Timothy J. Kehoe & David K. Levine, 1993. "Debt-Constrained Asset Markets," Review of Economic Studies, Oxford University Press, vol. 60(4), pages 865-888.
  5. Thomas, J. P., 1992. "Sovereign debt: Ignorance can be bliss," Journal of Development Economics, Elsevier, vol. 39(2), pages 389-396, October.
  6. Mark L. J. Wright, 2004. "Private capital flows, capital controls, and default risk," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
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  8. V. V. Chari & Patrick J. Kehoe, 1989. "Sustainable plans and debt," Staff Report 125, Federal Reserve Bank of Minneapolis.
  9. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
  10. Ricardo de O. Cavalcanti & Andres Erosa & Ted Temzelides, 1999. "Private Money and Reserve Management in a Random-Matching Model," Journal of Political Economy, University of Chicago Press, vol. 107(5), pages 929-945, October.
  11. Kenneth M. Kletzer and Brian D. Wright., 1998. "Sovereign Debt as Intertemporal Barter," Center for International and Development Economics Research (CIDER) Working Papers C98-100, University of California at Berkeley.
  12. Karsten Jeske, 2006. "Private International Debt with Risk of Repudiation," Journal of Political Economy, University of Chicago Press, vol. 114(3), pages 576-593, June.
  13. Jonathan Eaton & Mark Gersovitz, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Oxford University Press, vol. 48(2), pages 289-309.
  14. Dirk Kreuger & Fabrizio Perri, 2002. "Does Income Inequality Lead to Consumption Inequality? Evidence and Theory," Working Papers 02-15, New York University, Leonard N. Stern School of Business, Department of Economics.
  15. Herschel I. Grossman & T. Han, 1997. "Sovereign Debt and Consumption Smoothing," Working Papers 97-6, Brown University, Department of Economics.
  16. Dirk Krueger & Harald Uhlig, 2003. "Competitive Risk Sharing Contracts with One-Sided Commitment," NBER Working Papers 10135, National Bureau of Economic Research, Inc.
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  18. Timothy J. Kehoe & David K. Levine, 1993. "Debt-Constrained Asset Markets," Review of Economic Studies, Oxford University Press, vol. 60(4), pages 865-888.
  19. Gourinchas, Pierre-Olivier & Rey, Hélène, 2005. "From World Banker to World Venture Capitalist: US External Adjustment and The Exorbitant Privilege," CEPR Discussion Papers 5220, C.E.P.R. Discussion Papers.
  20. repec:oup:restud:v:73:y:2006:i:1:p:163-193 is not listed on IDEAS
  21. Narayana R. Kocherlakota, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Oxford University Press, vol. 63(4), pages 595-609.
  22. V. V. Chari & Patrick J. Kehoe, 1989. "Sustainable plans," Staff Report 122, Federal Reserve Bank of Minneapolis.
  23. Aleksander Berentsen & Gabriele Camera & Christopher Waller, 2005. "Money, Credit and Banking," CESifo Working Paper Series 1617, CESifo Group Munich.
  24. Hanno Lustig, 2004. "The Market Price of Aggregate Risk and the Wealth Distribution," UCLA Economics Online Papers 299, UCLA Department of Economics.
  25. Kocherlakota, N.R., 1990. "Bubbles and Constraints on Debt Accumulation," Working Papers 90-29, University of Iowa, Department of Economics.
  26. Manuel S. Santos & Michael Woodford, 1993. "Rational Asset Pricing Bubbles," Working Papers 9304, Centro de Investigacion Economica, ITAM.
  27. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September.
  28. Jeremy Bulow & Kenneth Rogoff, 1998. "Sovereign Debt: Is to Forgive to Forget," Levine's Working Paper Archive 209, David K. Levine.
  29. Woodford, Michael, 1990. "Public Debt as Private Liquidity," American Economic Review, American Economic Association, vol. 80(2), pages 382-88, May.
  30. Wolfgang Pesendorfer, 1992. "Sovereign Debt: Forgiving and Forgetting Reconsidered," Discussion Papers 1016, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  31. Cole, Harold L. & Kehoe, Patrick J., 1995. "The role of institutions in reputation models of sovereign debt," Journal of Monetary Economics, Elsevier, vol. 35(1), pages 45-64, February.
  32. Jaume Ventura, 2004. "Bubbles and capital flows," 2004 Meeting Papers 102, Society for Economic Dynamics.
  33. Cole, Harold L & Kehoe, Patrick J, 1998. "Models of Sovereign Debt: Partial versus General Reputations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(1), pages 55-70, February.
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