Working Paper: NBER ID: w21026
Authors: Juan Carlos Conesa; Timothy J. Kehoe
Abstract: We develop a model for analyzing the sovereign debt crises of 2010–2013 in the Eurozone. The government sets its expenditure-debt policy optimally. The need to sell large quantities of bonds every period leaves the government vulnerable to self-fulfilling crises in which investors, anticipating a crisis, are unwilling to buy the bonds, thereby provoking the crisis. In this situation, the optimal policy of the government is to reduce its debt to a level where crises are not possible. If, however, the economy is in a recession where there is a positive probability of recovery in fiscal revenues, the government may optimally choose to “gamble for redemption,” running deficits and increasing its debt, thereby increasing its vulnerability to crises.
Keywords: Sovereign debt crises; Self-fulfilling crises; Fiscal policy
JEL Codes: F34; F45; G01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Recession (E32) | Government increases debt (H63) |
| Government increases debt (H63) | Increased vulnerability to self-fulfilling debt crises (F65) |
| Recession (E32) | Increased vulnerability to self-fulfilling debt crises (F65) |
| Government does not manage debt effectively (H63) | Risks entering a crisis zone (H12) |