Preventing Self-Fulfilling Debt Crises: A Global Games Approach

Michal Szkup

Review of Economic Dynamics, 2022, vol. 43, 22-55

Abstract: This paper develops a micro-founded global games model of debt crises. I use this model to study which policies can help to prevent expectations-driven crises and how the desirability of such policies depends on market participants' expectations and the presence of economic policy uncertainty. I show that endogenous expectations amplify the effects of government policies, so that even a small policy adjustment can have significant effects. I find that policy uncertainty may increase the range of situations in which government policies can help prevent a crisis but decrease their overall impact. Finally, I apply these insights to study two policies that are often at the center of political discussions: austerity (an increase in taxes) and government stimulus. I show that under plausible conditions an increase in taxes is preferable to a government stimulus, and that policy uncertainty further increases the relative attractiveness of austerity. (Copyright: Elsevier)

Keywords: Sovereign debt crises; Global games; Expectations; Policy uncertainty; Taxes; Stimulus (search for similar items in EconPapers)
JEL-codes: C72 D82 D84 F34 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1016/j.red.2020.12.002

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