The Mystery of the Printing Press: Self-fulfilling debt crises and monetary sovereignty

Giancarlo Corsetti and Luca Dedola ()

No 9358, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Building on Calvo (1988), we develop a stochastic monetary economy in which government default may be driven by either self-fulfilling expectations or weak fundamentals, and explore conditions under which central banks can rule out the former. We analyze monetary backstops resting on the ability of the central bank to swap government debt for its monetary liabilities, whose demand is not undermined by fears of default. To be effective, announced interventions must be credible, i.e., feasible and welfare improving. Absent fundamental default risk, a monetary backstop is always effective in preventing self-fulfilling crises. In the presence of fundamental default risk and institutional constraints on the balance sheet of the central bank, a credible monetary backstop is likely to fall short of covering government's financial needs in full. It is thus effective to the extent that it increases the level of debt below which the equilibrium is unique.

Keywords: Debt monetization; Lender of last resort; Seigniorage; Sovereign risk and default (search for similar items in EconPapers)
JEL-codes: E58 E63 H63 (search for similar items in EconPapers)
Date: 2013-02
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (39)

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Related works:
Working Paper: The "Mystery of the Printing Press" Monetary Policy and Self-fulfilling Debt Crises (2016)
Working Paper: The "Mystery of the Printing Press" Monetary Policy and Self-fulfilling Debt Crises (2014)
Working Paper: The "Mystery of the Printing Press" Monetary Policy and Self-fulfilling Debt Crises (2014)
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