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The Mystery of the Printing Press: Self-fulfilling debt crises and monetary sovereignty

  • Corsetti, Giancarlo
  • Dedola, Luca
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    Building on Calvo (1988), we develop a stochastic monetary economy in which government default may be driven by either self-fulfilling expectations or weak fundamentals, and explore conditions under which central banks can rule out the former. We analyze monetary backstops resting on the ability of the central bank to swap government debt for its monetary liabilities, whose demand is not undermined by fears of default. To be effective, announced interventions must be credible, i.e., feasible and welfare improving. Absent fundamental default risk, a monetary backstop is always effective in preventing self-fulfilling crises. In the presence of fundamental default risk and institutional constraints on the balance sheet of the central bank, a credible monetary backstop is likely to fall short of covering government's financial needs in full. It is thus effective to the extent that it increases the level of debt below which the equilibrium is unique.

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    Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9358.

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    Date of creation: Feb 2013
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    Handle: RePEc:cpr:ceprdp:9358
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    1. Tirole, Jean, 2012. "Country Solidarity, Private Sector Involvement and the Contagion of Sovereign Crises," IDEI Working Papers 761, Institut d'Économie Industrielle (IDEI), Toulouse, revised Sep 2012.
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    3. Javier Díaz-Giménez & Giorgia Giovanetti & Ramon Marimon & Pedro Teles, 2003. "Nominal Debt as a Burden on Monetary Policy," Working Papers 8, Barcelona Graduate School of Economics.
    4. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-Fulfilling Debt Crises," Levine's Working Paper Archive 114, David K. Levine.
    5. Stephen Morris & Hyun Song Shin, 2004. "Catalytic Finance: When Does It Work?," Yale School of Management Working Papers ysm339, Yale School of Management.
    6. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-61, September.
    7. Cohen, Daniel & Villemot, Sébastien, 2011. "Endogenous debt crises," CEPR Discussion Papers 8270, C.E.P.R. Discussion Papers.
    8. Zwart, Sanne, 2007. "The mixed blessing of IMF intervention: Signalling versus liquidity support," Journal of Financial Stability, Elsevier, vol. 3(2), pages 149-174, July.
    9. Fernando M. Martin, 2004. "A Positive Theory of Government Debt," Macroeconomics 0408013, EconWPA, revised 12 Oct 2004.
    10. Harald Uhlig, 2011. "The dynamics of sovereign debt crises in a monetary union," 2011 Meeting Papers 482, Society for Economic Dynamics.
    11. Goodfriend, Marvin, 2011. "Central banking in the credit turmoil: An assessment of Federal Reserve practice," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 1-12, January.
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