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Self-fulfilling debt crises: What can monetary policy do?

Philippe Bacchetta (), Elena Perazzi () and Eric van Wincoop

Journal of International Economics, 2018, vol. 110, issue C, 119-134

Abstract: This paper examines 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. Monetary policy could preclude a debt crisis through raising inflation and output and lowering the real interest rate. These reduce the real value of outstanding debt and the cost of new borrowing, and increase tax revenues and seigniorage. We determine the optimal path of inflation required to avoid a self-fulfilling debt crisis. Stronger price rigidity implies more sustained inflation.

Keywords: Debt crisis; -self-fulfilling; monetary policy (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:eee:inecon:v:110:y:2018:i:c:p:119-134