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

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

Cahiers de Recherches Economiques du Département d'économie from Université de Lausanne, Faculté des HEC, Département d’économie

Abstract: This paper examines quantitatively the potential for monetary policy to avoid self-fullling 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. Under conventional policy the central bank can preclude a debt crisis through inflation, lowering the real interest rate and raising output. These reduce the real value of the outstanding debt and the cost of new borrowing, and increase tax revenues and seigniorage. Unconventional policies take the form of liquidity support or debt buyback policies that raise the monetary base beyond the satiation level. We find that generally the central bank cannot credibly avoid a self-fulfilling debt crisis. Conventional policies needed to avert a crisis require excessive inflation for a sustained period of time. Unconventional monetary policy can only be effective when the economy is at a structural ZLB for a sustained length of time.

Keywords: Monetary Policy; Sovereign Debt; Self-fulfilling Crises (search for similar items in EconPapers)
JEL-codes: E52 E60 E63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Date: 2015-06
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Working Paper: Self-Fulfilling Debt Crises: Can Monetary Policy Really Help? (2015) Downloads
Working Paper: Self-Fulfilling Debt Crises: Can Monetary Policy Really Help? (2015) Downloads
Working Paper: Self-Fulfilling Debt Crises: Can Monetary Policy Really Help? (2015) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:lau:crdeep:15.06

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