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Why Prices Don't Respond Sooner to a Prospective Sovereign Debt Crisis

  • R. Anton Braun

    ()

    (Federal Reserve Bank of Atlanta)

  • Tomoyuki Nakajima

    ()

    (Kyoto University)

We compare the dynamics of in flation and bond yields leading up to a sovereign debt crisis in settings where asset markets are frictionless to other settings with financial fric- tions. As compared to the case with frictionless asset markets, an asset market structure with financial frictions generates a significant delay in the response of prices to news about a future debt crisis. With complete markets prices jump in response to news about the possibility of a future debt crisis. However, when short selling of government bonds is restricted some agents can't act on their beliefs and prices don't respond to the news. Instead prices only move in periods immediately prior the crisis.

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File URL: http://www.kier.kyoto-u.ac.jp/DP/DP796.pdf
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Paper provided by Kyoto University, Institute of Economic Research in its series KIER Working Papers with number 796.

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Length: 37pages
Date of creation: Nov 2011
Date of revision:
Handle: RePEc:kyo:wpaper:796
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  1. Bi, Huixin, 2012. "Sovereign default risk premia, fiscal limits, and fiscal policy," European Economic Review, Elsevier, vol. 56(3), pages 389-410.
  2. Carmen M. Reinhart & Kenneth S. Rogoff, 2011. "From Financial Crash to Debt Crisis," American Economic Review, American Economic Association, vol. 101(5), pages 1676-1706, August.
  3. Davig, Troy & Leeper, Eric M. & Walker, Todd B., 2011. "Inflation and the fiscal limit," European Economic Review, Elsevier, vol. 55(1), pages 31-47, January.
  4. Marco Bassetto, 2001. "A game-theoretic view of the fiscal theory of the price level," Working Papers 612, Federal Reserve Bank of Minneapolis.
  5. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  6. Sebastián Nieto Parra, 2008. "Who Saw Sovereign Debt Crises Coming?," OECD Development Centre Working Papers 274, OECD Publishing.
  7. Marco Bassetto & R. Andrew Butters, 2010. "What is the relationship between large deficits and inflation in industrialized countries?," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q III, pages 83-100.
  8. Selahattin Imrohoroglu & Nao Sudo, 2010. "Productivity and Fiscal Policy in Japan: Short Term Forecasts from the Standard Growth Model," IMES Discussion Paper Series 10-E-23, Institute for Monetary and Economic Studies, Bank of Japan.
  9. John Geanakoplos & Ana Fostel, 2008. "Leverage Cycles and the Anxious Economy," American Economic Review, American Economic Association, vol. 98(4), pages 1211-44, September.
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