Self-Fulfilling Debt Crises: Can Monetary Policy Really Help?

Eric van Wincoop and Philippe Bacchetta
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Eric van Wincoop: University of Virginia

No 925, 2015 Meeting Papers from Society for Economic Dynamics

Abstract: This paper examines quantitatively the potential for monetary policy to avoid self-fulfilling sovereign debt crises. We combine a version of the slow-moving debt crisis model proposed by Lorenzoni and Werning (2014) with a standard New Keynesian model. We consider both conventional and unconventional monetary policy. With price rigidity, the real cost of debt can be reduced through lower real interest rates. On the other hand, deflation of long-term debt is less effective and requires higher inflation rates. In general, we show that crisis equilibria can only be avoided with steep inflation rates for a sustained period of time, the cost of which is likely to be much larger than government default.

Date: 2015
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-opm
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Working Paper: Self-Fulfilling Debt Crises: Can Monetary Policy Really Help? (2015)
Working Paper: Self-Fulfilling Debt Crises: Can Monetary Policy Really Help? (2015)
Working Paper: Self-Fulfilling Debt Crises: Can Monetary Policy Really Help? (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed015:925

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