Self-fulfilling debt crises

Harold L. Cole, Timothy J Kehoe

Research output: Contribution to journalArticle

184 Citations (Scopus)

Abstract

We characterize the values of government debt and the debt's maturity structure under which financial crises brought on by a loss of confidence in the government can arise within a dynamic, stochastic general equilibrium model. We also characterize the optimal policy response of the government to the threat of such a crisis. We show that when the country's fundamentals place it inside the crisis zone, the government may be motivated to reduce its debt and exit the crisis zone because this leads to an economic boom and a reduction in the interest rate on the government's debt. We show that this reduction can be gradual if debt is high or the probability of a crisis is low. We also show that, while lengthening the maturity of the debt can shrink the crisis zone, credibility-inducing policies can have perverse effects.

Original languageEnglish (US)
Pages (from-to)91-116
Number of pages26
JournalReview of Economic Studies
Volume67
Issue number1
DOIs
StatePublished - Jan 1 2000

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Debt crisis
Debt
Government
Government debt
Optimal policy
Financial crisis
Economics
Policy responses
Exit
Maturity
Interest rates
Debt maturity structure
Credibility
Confidence
Threat
Dynamic stochastic general equilibrium model

Cite this

Self-fulfilling debt crises. / Cole, Harold L.; Kehoe, Timothy J.

In: Review of Economic Studies, Vol. 67, No. 1, 01.01.2000, p. 91-116.

Research output: Contribution to journalArticle

Cole, Harold L. ; Kehoe, Timothy J. / Self-fulfilling debt crises. In: Review of Economic Studies. 2000 ; Vol. 67, No. 1. pp. 91-116.
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