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Gambling for Redemption and Self-Fulfilling Debt Crises

Author

Listed:
  • Timothy Kehoe

    (University of Minnesota)

  • Juan Carlos Conesa

    (Universitat Autonoma de Barcelona)

Abstract

We develop a model for analyzing the sovereign debt crises of 2010 and 2011 in such European countries as Greece, Ireland, and Portugal. The government sets its expenditure-debt policy optimally given a fixed probability of a recovery in fiscal revenues. In doing so, the government can optimally choose to “gamble for redemption,†and the economy can be optimally driven to a level of debt that increases its vulnerability to self-fulfilling debt crises. The model explains why, in contrast to the Mexican crisis of 1994–95, where a loan package put together by U.S. President Bill Clinton put an immediate end to the crisis, rescue packages put together by the European Union do not seem to have ended the crises in Greece, Ireland, or Portugal.

Suggested Citation

  • Timothy Kehoe & Juan Carlos Conesa, 2012. "Gambling for Redemption and Self-Fulfilling Debt Crises," 2012 Meeting Papers 614, Society for Economic Dynamics.
  • Handle: RePEc:red:sed012:614
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F45 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Macroeconomic Issues of Monetary Unions
    • G01 - Financial Economics - - General - - - Financial Crises

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