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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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