Working Paper: NBER ID: w24683
Authors: Mark A. Aguiar; Manuel Amador
Abstract: We establish that creditor beliefs regarding future borrowing can be self-fulfilling, leading to multiple equilibria with markedly different debt accumulation patterns. We characterize such indeterminacy in the Eaton-Gersovitz sovereign debt model augmented with long maturity bonds. Two necessary conditions for the multiplicity are: (i) the government is more impatient than foreign creditors, and (ii) there are deadweight losses from default; both are realistic and standard assumptions in the quantitative literature. The multiplicity is dynamic and stems from the self-fulfilling beliefs of how future creditors will price bonds; long maturity bonds are therefore a crucial component of the multiplicity. We introduce a third party with deep pockets to discuss the policy implications of this source of multiplicity and identify the potentially perverse consequences of traditional “lender of last resort” policies.
Keywords: No keywords provided
JEL Codes: F3; F34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Creditor beliefs regarding future borrowing (G21) | self-fulfilling debt crises (F34) |
| Government's relative impatience compared to foreign creditors (F34) | borrowing behavior (G51) |
| Presence of deadweight losses from default (G33) | incentives to manage debt levels carefully (H63) |
| Government's relative impatience compared to foreign creditors + Presence of deadweight losses from default (H69) | dynamic multiplicity in equilibria (C62) |
| Long maturity bonds (G12) | government's incentives to save or borrow (E62) |