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Lifetime-Laffer Curves and the Eurozone Crisis

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  • Zachary Stangebye

    (University of Notre Dame)

Abstract

In a finite-horizon model of sovereign debt and default, I show that long-term debt and the lack of ability to commit to future debt issuance can give rise to a multiplicity of debt and spread trajectories despite the ability to commit to contemporaneous debt issuance in terminal periods. This multiplicity bears resemblance to recent events in the Peripheral Eurozone. In a simple calibrated exercise, I find that 380 basis points (84.6%) of the spread during the crisis may be imputable to such coordination failures; if the model is extended to include bank bailouts, it can also explain 46.63 percentage points (37.8%) of the debt-to-GDP build-up. Policy analysis reveals that both austerity measures and liquidity provision by the central bank can eliminate malignant debt trajectories, but that the latter is more likely to have resolved the crisis.

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  • Zachary Stangebye, 2016. "Lifetime-Laffer Curves and the Eurozone Crisis," 2016 Meeting Papers 63, Society for Economic Dynamics.
  • Handle: RePEc:red:sed016:63
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    References listed on IDEAS

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    1. Juan Carlos Conesa & Timothy J. Kehoe, 2017. "Gambling for redemption and self-fulfilling debt crises," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 64(4), pages 707-740, December.
    2. Broner, Fernando & Erce, Aitor & Martin, Alberto & Ventura, Jaume, 2014. "Sovereign debt markets in turbulent times: Creditor discrimination and crowding-out effects," Journal of Monetary Economics, Elsevier, vol. 61(C), pages 114-142.
    3. Sosa-Padilla, César, 2018. "Sovereign defaults and banking crises," Journal of Monetary Economics, Elsevier, vol. 99(C), pages 88-105.
    4. Cole, Harold L. & Kehoe, Timothy J., 1996. "A self-fulfilling model of Mexico's 1994-1995 debt crisis," Journal of International Economics, Elsevier, vol. 41(3-4), pages 309-330, November.
    5. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, vol. 98(3), pages 690-712, June.
    6. Luigi Bocola, 2016. "The Pass-Through of Sovereign Risk," Journal of Political Economy, University of Chicago Press, vol. 124(4), pages 879-926.
    7. Jonathan Eaton & Mark Gersovitz, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Oxford University Press, vol. 48(2), pages 289-309.
    8. Stangebye, Zachary, 2015. "Dynamic Panics: Theory and Application to the Eurozone," MPRA Paper 69967, University Library of Munich, Germany.
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    Cited by:

    1. Kikkawa, Ayumu Ken & Sasahara, Akira, 2020. "Gains from trade and the sovereign bond market," European Economic Review, Elsevier, vol. 124(C).

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