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Is Inflation Default? The Role of Information in Debt Crises

Carlo Galli () and Marco Bassetto

No 308, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: In the aftermath of the financial crisis, countries which had control over their monetary policy, such as the United States, the United Kingdom, and Japan, were able to borrow at extremely low rates, even though they experienced very high deficit/GDP ratios (the UK) or debt/GDP ratios (Japan). In contrast, peripheral Eurozone countries with a high deficit/GDP ratio (Spain) or a high debt/GDP ratio (Italy) faced volatile interest rates. In a frictionless benchmark, default and inflation have the same economic effect. Creditors care about the real rate of return on their investment: whether they anticipate losing money to default or inflation, they will require an identical interest rate spread over risk-free bonds. We break this equivalence by introducing two classes of heterogeneously informed agents: bondholders, who decide whether to roll over their credit, and workers, who decide whether to accept currency in payment for their services. Domestic and foreign-currency borrowing are now distinguished by the identity of the marginal agent who triggers a crisis. We show conditions under which domestic-currency debt makes the economy more resilient to fiscal shocks.

New Economics Papers: this item is included in nep-cse, nep-mac and nep-mon
Date: 2016
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Related works:
Working Paper: Is Inflation Default? The Role of Information in Debt Crises (2017) Downloads
Working Paper: Is inflation default? The role of information in debt crises (2017) Downloads
Working Paper: Is Inflation Default? The Role of Information in Debt Crises (2017) Downloads
Working Paper: Is inflation default? The role of information in debt crises (2017) Downloads
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More papers in 2016 Meeting Papers from Society for Economic Dynamics Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA. Contact information at EDIRC.
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