Crisis and Commitment: Inflation Credibility and the Vulnerability to Sovereign Debt Crises
Mark Aguiar,
Manuel Amador,
Emmanuel Farhi and
Gita Gopinath
No 19516, NBER Working Papers from National Bureau of Economic Research, Inc
Abstract:
We propose a continuous time model of nominal debt and investigate the role of inflation credibility in the potential for self-fulfilling debt crises. Inflation is costly, but reduces the real value of outstanding debt without the full punishment of default. With high inflation credibility, which can be interpreted as joining a monetary union or issuing foreign currency debt, debt is effectively real. By contrast, with low inflation credibility, sovereign debt is nominal and in a debt crisis a government may opt to inflate away a fraction of the debt burden rather than explicitly default. This flexibility potentially reduces the country's exposure to self-fulfilling crises. On the other hand, the government lacks credibility not to inflate in the absence of crisis. This latter channel raises the cost of debt in tranquil periods and makes default more attractive in the event of a crisis, increasing the country's vulnerability. We characterize the interaction of these two forces. We show that there is an intermediate inflation credibility that minimizes the country's exposure to rollover risk. Low inflation credibility brings the worst of both worlds--high inflation in tranquil periods and increased vulnerability to a crisis.
JEL-codes: E31 E4 E62 F34 G15 (search for similar items in EconPapers)
Date: 2013-10
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-opm
Note: EFG IFM ME
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (90)
Downloads: (external link)
http://www.nber.org/papers/w19516.pdf (application/pdf)
Related works:
Working Paper: Crisis and Commitment: Inflation Credibility and the Vulnerability to Sovereign Debt Crises (2013) 
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
HTML/Text
Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:19516
Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w19516
Access Statistics for this paper
More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().