Creator: Ayres, João, Navarro, Gaston, Nicolini, Juan Pablo, and Teles, Pedro Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 757 Abstract:
We explore quantitatively the possibility of multiple equilibria in a model of sovereign debt crises. The source of multiplicity is the one identified by Calvo (1988). This type of multiplicity has been at the heart of the policy debate through the recent European sovereign debt crisis. Key for multiplicity in the model is a stochastic process for output featuring long periods of either high or low growth. We calibrate the output process in the model using data for the southern European countries that were exposed to the debt crisis. We find that expectations-driven sovereign debt crises are empirically plausible, but only in periods of stagnation. Multiplicity is state dependent: in periods of stagnation and for intermediate levels of debt, interest rates may be high for reasons unrelated to fundamentals.
Keyword: Good and bad times, Multiplicity, Sovereign default, Self-fulfilling debt crises, and Stagnation Subject (JEL): E44 - Financial Markets and the Macroeconomy and F34 - International Lending and Debt Problems