NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Gambling for Redemption and Self-Fulfilling Debt Crises

Juan Carlos Conesa, Timothy J. Kehoe

NBER Working Paper No. 21026
Issued in March 2015, Revised in October 2017
NBER Program(s):The Economic Fluctuations and Growth Program, The International Finance and Macroeconomics Program

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.

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Document Object Identifier (DOI): 10.3386/w21026

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