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Collateral, Liquidity and Debt Sustainability

Author

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  • Stefan Niemann

    () (Department of Economics, University of Essex, United Kingdom.)

  • Paul Pichler

    () (Economic Studies Division, Oesterreichische Nationalbank, Austria)

Abstract

We study the sustainability of public debt in a closed production economy where a benevolent government chooses scal policies, including haircuts on its outstanding debt, in a discretionary manner. Government bonds are held by domestic agents to smooth consumption over time and because they provide collateral and liquidity services. We characterize a recursive equilibrium where public debt amounts to a sizeable fraction of output in steady state and is nevertheless fully serviced by the government. In a calibrated economy, steady state debt amounts to around 84% of output, the government's default threshold is at around 94% of output, and the haircut on outstanding debt at this threshold is around 40%. Both reputational costs of default and contemporaneous costs due to lost collateral and liquidity are essential to generate these empirically plausible predictions.

Suggested Citation

  • Stefan Niemann & Paul Pichler, 2013. "Collateral, Liquidity and Debt Sustainability," Working Papers 187, Oesterreichische Nationalbank (Austrian Central Bank).
  • Handle: RePEc:onb:oenbwp:187
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    References listed on IDEAS

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    Cited by:

    1. Engler, Philipp & Große Steffen, Christoph, 2016. "Sovereign risk, interbank freezes, and aggregate fluctuations," European Economic Review, Elsevier, vol. 87(C), pages 34-61.
    2. Stefan Niemann & Paul Pichler, 2017. "Optimal fiscal policy and sovereign debt crises," Working Papers 218, Oesterreichische Nationalbank (Austrian Central Bank).
    3. Sosa-Padilla, Cesar, 2012. "Sovereign Defaults and Banking Crises," MPRA Paper 41074, University Library of Munich, Germany.
    4. Scholl, Almuth & Kaas, Leo & Meller, Jan, 2016. "Sovereign and Private Default Risks over the Business Cycle," Annual Conference 2016 (Augsburg): Demographic Change 145958, Verein für Socialpolitik / German Economic Association.

    More about this item

    Keywords

    sustainability; nancial frictions; sovereign default; domestic debt; endogenous haircut;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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