A self-fulfilling model of Mexico's 1994-1995 debt crisis

Harold L. Cole, Timothy J. Kehoe

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156 Scopus citations

Abstract

This paper explores the extent to which the Mexican government's inability to roll over its debt during December 1994 and January 1995 can be modeled as a self-fulfilling debt crisis. In the model there is a crucial interval of debt for which the government, although it finds it optimal to repay old debt if it can sell new debt, finds it optimal to default if it cannot sell new debt. If government debt is in this interval, which we call the crisis zone, then we can construct equilibria in which a crisis can occur stochastically, depending on the realization of a sunspot variable. The size of this zone depends on the average length of maturity of government debt. Our analysis suggests that for a country, like Mexico, with a very short maturity structure of debt, the crisis zone is large and includes levels of debt as low as those in Mexico before the crisis.

Original languageEnglish (US)
Pages (from-to)309-330
Number of pages22
JournalJournal of International Economics
Volume41
Issue number3-4
DOIs
StatePublished - Nov 1996

Bibliographical note

Funding Information:
We are grateful to seminar participants at several institutions, especially to Carlos Vegh and Edward Green and to two anonymous referees. The research of the second author has been supported by a grant from the Air Force Office of Scientific Research, Air Force Material Command, USAF, under grant number F4962094-l-0461. The U.S. government is authorized to reproduce and distribute reprints for government purposesn ot withstanding any copyright notation thereon. The views expressed herein are those of the authors and not necessarily of the Federal Reserve Bank of Minneapolis, the Federal Reserve System, the Air Force Office of Scientific Research,o r the U.S. government.

Keywords

  • Debt crisis
  • Mexico
  • Sunspot

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