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The Domestic Debt Intolerance and Bad Equilibrium: An Empirical Default Model

  • Ozkaya, Ata


    (Galatasaray University Economic Research Center)

The Turkish financial crises 1994 and 2000-2001 are spaced some years apart, creating an illusion that this time is different among policymakers and investors. Suppose that the dynamics of the macroeconomy generates multiple values for the domestic interest rate premium : "low" and "high". The sudden shifts in financial markets that characterize financial crises are then interpreted as a shift from one equilibrium to another. In this paper, we specify a dynamic model in which debt default through inflation is possible, determine its closed-form solution and multiple equilibria. We estimate the model using the properties of chaos theory, against post-liberalization period (1989-2010) data for Turkey. The problem takes as given our model economy with multiple equilibria and asks whether the multiple equilibria can be verified by the data. To make progress on this problem we introduce phase-space portrait of the considered economy and identify path for debt dynamics moving from low and diverging through high interest levels. Second, we measure how the default episodes 1994 and 2000-2001 converge/diverge apart on phase-space, depending on the maximal Lyapunov exponent. Since the data show support for the multiple-equilibrium explanation of the serial defaults, we better understand the significance of domestic debt behind the high inflation, banking crises and currency crashes that Turkish economy frequently experienced in its postliberalization period.

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Paper provided by Galatasaray University Economic Research Center in its series GIAM Working Papers with number 13-1.

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Length: 21 pages
Date of creation: 04 Feb 2013
Date of revision:
Handle: RePEc:ris:giamwp:2013_001
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