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Credit markets, limited commitment, and government debt

  • Williamson, Stephen D.

    (Washington University in St. Louis)

  • Carapella, Francesca

    (Board of Governors of the Federal Reserve System)

A dynamic model with credit under limited commitment is constructed, in which limited memory can weaken the effects of punishment for default. This creates an endogenous role for government debt in credit markets, and the economy can be non-Ricardian. Default can occur in equilibrium, and government debt essentially plays a role as collateral and thus improves borrowers’ incentives. The provision of government debt acts to discourage default, whether default occurs in equilibrium or not.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2014-10.

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Length: 41 pages
Date of creation: 24 Feb 2014
Date of revision:
Handle: RePEc:fip:fedlwp:2014-010
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  1. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  2. Kocherlakota, Narayana R, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 595-609, October.
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  8. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  9. Aiyagari, S. Rao & Williamson, Stephen, 1997. "Money and Dynamic Credit Arrangements with Private Information," Working Papers 97-19, University of Iowa, Department of Economics.
  10. Narayana R. Kocherlakota, 1996. "Money is memory," Staff Report 218, Federal Reserve Bank of Minneapolis.
  11. Mailath George J. & Okuno-Fujiwara Masahiro & Postlewaite Andrew, 1993. "Belief-Based Refinements in Signalling Games," Journal of Economic Theory, Elsevier, vol. 60(2), pages 241-276, August.
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  13. David Andolfatto, 2011. "The simple analytics of money and credit in a quasi-linear environment," Working Papers 2011-038, Federal Reserve Bank of St. Louis.
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