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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; for the latter, there exist well known existence and characterization results. In contrast to the classic result by Bulow and Rogoff (AER 1989), positive levels of debt are sustainable in our environment because the interest rate is sufficiently low to provide repayment incentives.

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File URL: http://www.nber.org/papers/w12614.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12614.

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Date of creation: Oct 2006
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Publication status: published as Christian Hellwig & Guido Lorenzoni, 2009. "Bubbles and Self-Enforcing Debt," Econometrica, Econometric Society, vol. 77(4), pages 1137-1164, 07.
Handle: RePEc:nbr:nberwo:12614
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  1. Wolfgang Pesendorfer, 1992. "Sovereign Debt: Forgiving and Forgetting Reconsidered," Discussion Papers 1016, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. Ricardo de O. Cavalcanti & Andres Erosa & Ted Temzelides, 1999. "Private Money and Reserve Management in a Random-Matching Model," Journal of Political Economy, University of Chicago Press, vol. 107(5), pages 929-945, October.
  3. John Kareken & Neil Wallace, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 96(2), pages 207-222.
  4. 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.
  5. Jeremy Bulow & Kenneth Rogoff, 1998. "Sovereign Debt: Is to Forgive to Forget," Levine's Working Paper Archive 209, David K. Levine.
  6. Chari V. V. & Kehoe Patrick J., 1993. "Sustainable Plans and Debt," Journal of Economic Theory, Elsevier, vol. 61(2), pages 230-261, December.
  7. Timothy J Kehoe & David K Levine, 1993. "Debt Constrained Asset Markets," Levine's Working Paper Archive 1276, David K. Levine.
  8. Manuel S. Santos & Michael Woodford, 1997. "Rational Asset Pricing Bubbles," Econometrica, Econometric Society, vol. 65(1), pages 19-58, January.
  9. Dirk Kreuger & Fabrizio Perri, 2002. "Does Income Inequality Lead to Consumption Inequality? Evidence and Theory," Working Papers 02-15, New York University, Leonard N. Stern School of Business, Department of Economics.
  10. Krueger, Dirk & Uhlig, Harald, 2006. "Competitive risk sharing contracts with one-sided commitment," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1661-1691, October.
  11. Herschel I. Grossman & T. Han, 1997. "Sovereign Debt and Consumption Smoothing," Working Papers 97-6, Brown University, Department of Economics.
  12. Kenneth M. Kletzer & Brian D. Wright, 2000. "Sovereign Debt as Intertemporal Barter," International Finance 0003004, EconWPA.
  13. Ventura, Jaume, 2002. "Bubbles and Capital Flows," CEPR Discussion Papers 3657, C.E.P.R. Discussion Papers.
  14. 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.
  15. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September.
  16. repec:oup:restud:v:60:y:1993:i:4:p:865-88 is not listed on IDEAS
  17. 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.
  18. Hanno Lustig & Yi-Li Chien, 2005. "The Market Price of Aggregate Risk and the Wealth Distribution," NBER Working Papers 11132, National Bureau of Economic Research, Inc.
  19. Bulow, Jeremy & Rogoff, Kenneth, 1989. "A Constant Recontracting Model of Sovereign Debt," Journal of Political Economy, University of Chicago Press, vol. 97(1), pages 155-78, February.
  20. W. Pesendorfer & F. Gul, 1999. "Self-Control and the Theory of Consumption," Princeton Economic Theory Papers 99f2, Economics Department, Princeton University.
  21. Scheinkman, Jose A & Weiss, Laurence, 1986. "Borrowing Constraints and Aggregate Economic Activity," Econometrica, Econometric Society, vol. 54(1), pages 23-45, January.
  22. Mark L. J. Wright, 2004. "Private capital flows, capital controls, and default risk," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  23. 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.
  24. 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.
  25. Aleksander Berentsen & Gabriele Camera, 2004. "Money, Credit, and Banking," 2004 Meeting Papers 473, Society for Economic Dynamics.
  26. V. V. Chari & Patrick J. Kehoe, 1989. "Sustainable plans," Staff Report 122, Federal Reserve Bank of Minneapolis.
  27. Kocherlakota, N.R., 1990. "Bubbles and Constraints on Debt Accumulation," Working Papers 90-29, University of Iowa, Department of Economics.
  28. Thomas, J. P., 1992. "Sovereign debt: Ignorance can be bliss," Journal of Development Economics, Elsevier, vol. 39(2), pages 389-396, October.
  29. Cole, Harold L & Kehoe, Patrick J, 1998. "Models of Sovereign Debt: Partial versus General Reputations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(1), pages 55-70, February.
  30. Woodford, Michael, 1990. "Public Debt as Private Liquidity," American Economic Review, American Economic Association, vol. 80(2), pages 382-88, May.
  31. repec:oup:restud:v:48:y:1981:i:2:p:289-309 is not listed on IDEAS
  32. repec:oup:restud:v:63:y:1996:i:4:p:595-609 is not listed on IDEAS
  33. Manuel Amador, 2004. "A Political Model Sovereign Debt Repayment," 2004 Meeting Papers 762, Society for Economic Dynamics.
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