Debt crises, fast and slow

Seminario Theory-Experimental

Giancarlo Corsetti

European University Institute

5-Apr-2023

seminar – 14:30

We build a dynamic model where the economy is vulnerable to belief-driven slow moving debt crises at intermediate debt level, and rollover crises at both low and high debt levels. Vis-à-vis the threat of slow-moving crises, countercyclical deficits generally welfare dominate debt reduction policies. In a recession, optimizing governments only deleverage if debt is close to the threshold below which belief-driven slow-moving crises can no longer occur. The welfare benefits from deleveraging instead dominate if governments are concerned with losing market access even at low debt levels. Long bond maturities may fully eliminate belief-driven rollover crises but not slow-moving ones.