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The Cambridge-INET Institute - continuing as the Janeway Institute

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Corsetti, G. and Maeng, S. H.

Debt Crises, Fast and Slow

WP Number: 2004

Abstract: We build a dynamic model to study how shifts in investors’ beliefs can drive either slow-moving debt crises or rollover crises. We show that the threat of slow-moving crises does not necessarily motivate deleveraging: in a recession, unless debt is close enough to the threshold at which the economy becomes vulnerable to such crises, optimizing governments keep borrowing, gambling on economic recovery. The incentive to deleverage is instead strong when the economy is vulnerable to rollover crises at low levels of debt. We show that equilibrium multiplicity remains pervasive independently of bond maturity. In general, short maturities induce more deleveraging.

Keywords: Sovereign default, Self-fulfilling crises, Expectations, Debt sustainability

JEL Codes: E43 E62 H50 H63

Author links: Giancarlo Corsetti  Fred Seunghyun Maeng  - Winner of CERF best student paper award

PDF: wp2004.pdf

Open Access Link: 10.17863/CAM.52416

Keynes Fund Project(s):
The Making of the Euro-area Crisis: Lessons from Theory and History (JHLP)  

Theme: transmission