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Collateral, liquidity and debt sustainability

Stefan Niemann and Paul Pichler ()

Economics Discussion Papers from University of Essex, Department of Economics

Abstract: We study the sustainability of public debt in a closed production economy where a benevolent government chooses fiscal policies, including haircuts on its outstanding debt, in a discretionary manner. Government bonds are held by domestic agents to smooth consumption over time and because they provide collateral and liquidity services. We characterize a recursive equilibrium where public debt amounts to a sizeable fraction of output in steady state and is nevertheless fully serviced by the government. In a calibrated economy, steady state debt amounts to around 84% of output, the government's default threshold is at around 94% of output, and the haircut on outstanding debt at this threshold is around 40%. Both reputational costs of default and contemporaneous costs due to lost collateral and liquidity are essential to generate these empirically plausible predictions.

Keywords: sustainability; financial frictions; sovereign default; domestic debt; endogenous haircut. (search for similar items in EconPapers)
Date: 2013
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Related works:
Journal Article: Collateral, Liquidity and Debt Sustainability (2017) Downloads
Working Paper: Collateral, liquidity and debt sustainability (2014) Downloads
Working Paper: Collateral, Liquidity and Debt Sustainability (2013) Downloads
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