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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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  2. Wright, Mark L.J., 2006. "Private capital flows, capital controls, and default risk," Journal of International Economics, Elsevier, vol. 69(1), pages 120-149, June.
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  12. Grossman, Herschel I. & Han, Taejoon, 1999. "Sovereign debt and consumption smoothing," Journal of Monetary Economics, Elsevier, vol. 44(1), pages 149-158, August.
  13. Bulow, Jeremy & Rogoff, Kenneth S., 1989. "A Constant Recontracting Model of Sovereign Debt," Scholarly Articles 12491028, Harvard University Department of Economics.
  14. Timothy J Kehoe & David K Levine, 1993. "Debt Constrained Asset Markets," Levine's Working Paper Archive 1276, David K. Levine.
  15. Ricardo de O. Cavalcanti & Andres Erosa & Ted Temzelides, 1999. "Private money and reserve management in a random-matching model," Discussion Paper / Institute for Empirical Macroeconomics 128, Federal Reserve Bank of Minneapolis.
  16. 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.
  17. Gourinchas, Pierre-Olivier & Rey, Hélène, 2005. "From World Banker to World Venture Capitalist: US External Adjustment and the Exorbitant Privilege," CEPREMAP Working Papers (Docweb) 0606, CEPREMAP.
  18. Hanno Lustig, 2004. "The Market Price of Aggregate Risk and the Wealth Distribution," UCLA Economics Online Papers 299, UCLA Department of Economics.
  19. 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.
  20. Manuel S. Santos & Michael Woodford, 1993. "Rational Asset Pricing Bubbles," Working Papers 9304, Centro de Investigacion Economica, ITAM.
  21. Aleksander Berentsen & Gabriele Camera, 2004. "Money, Credit, and Banking," 2004 Meeting Papers 473, Society for Economic Dynamics.
  22. W. Pesendorfer & F. Gul, 1999. "Self-Control and the Theory of Consumption," Princeton Economic Theory Papers 99f2, Economics Department, Princeton University.
  23. Chari V. V. & Kehoe Patrick J., 1993. "Sustainable Plans and Debt," Journal of Economic Theory, Elsevier, vol. 61(2), pages 230-261, December.
  24. Thomas, J. P., 1992. "Sovereign debt: Ignorance can be bliss," Journal of Development Economics, Elsevier, vol. 39(2), pages 389-396, October.
  25. Wolfgang Pesendorfer, 1992. "Sovereign Debt: Forgiving and Forgetting Reconsidered," Discussion Papers 1016, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  26. Harold L. Cole & Patrick J. Kehoe, 1994. "The role of institutions in reputation models of sovereign debt," Staff Report 179, Federal Reserve Bank of Minneapolis.
  27. Kareken, John & Wallace, Neil, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 96(2), pages 207-22, May.
  28. Manuel Amador, 2004. "A Political Model Sovereign Debt Repayment," 2004 Meeting Papers 762, Society for Economic Dynamics.
  29. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September.
  30. Krueger, Dirk & Uhlig, Harald, 2005. "Competitive risk sharing contracts with one-sided commitment," CFS Working Paper Series 2005/07, Center for Financial Studies (CFS).
  31. Dirk Krueger & Fabrizio Perri, 2006. "Does Income Inequality Lead to Consumption Inequality? Evidence and Theory -super-1," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 163-193.
  32. Kocherlakota, N.R., 1990. "Bubbles and Constraints on Debt Accumulation," Working Papers 90-29, University of Iowa, Department of Economics.
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