Economic Theory

, Volume 53, Issue 3, pp 499–535 | Cite as

Self-fulfilling crises with default and devaluation

  • José-María Da-Rocha
  • Eduardo-Luis Giménez
  • Francisco-Xavier Lores
Research Article


We characterize optimal debt policy in a dynamic stochastic general equilibrium model of defaults and devaluations in which self-fulfilling crises can arise. When the government cannot commit to repay its debt and cannot commit to maintain the exchange rate, consumers’ expectations of devaluation make the safe level of government debt very low. We show that, when the debt is in the crises zone—where self-fulfilling crisis can occur—the government finds it optimal to reduce the debt to exit the zone. The lower the probability that consumers assign to devaluation, however, the greater is the number of periods that the government will choose to take to exit the crisis zone. We argue that our model can help understand events in Argentina in 2001–2002 and throw light on some aspects of the current EMU sovereign debt crisis.


Default Devaluation Self-fulfilling crisis 

JEL Classification

E6 F3 F34 


Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.


  1. Antinolfi G., Huybens E.: Domestic financial market frictions, unrestricted international capital flows, and crises in small open economies. Econ. Theory 24(4), 811–837 (2004)CrossRefGoogle Scholar
  2. Calvo, G.A., Izquierdo, A., Talvi, E.: Sudden Stops, the Real Exchange Rate, and Fiscal Sustainability: Argentina’s Lessons. NNBER Working Paper 9828 (2003)Google Scholar
  3. Cole H.L., Kehoe T.J.: A self-fullfilling model of Mexico’s 1994–95 debt crisis. J. Int. Econ. 41, 309–330 (1996)CrossRefGoogle Scholar
  4. Cole H.L., Kehoe T.J.: Self-fullfilling debt crisis. Rev. Econ. Stud. 67, 91–116 (2000)CrossRefGoogle Scholar
  5. De la Torre, A., Levy Yeyati, E., Schmukler, S.L.: Living and Dying with Hard Pegs : The Rise and Fall of Argentina’s Currency Board. World Bank Policy Research Working Paper 2980 (2003)Google Scholar
  6. Garcia Pires, A.J.: International trade and competitiveness. Econ. Theory (2010). doi: 10.1007/s00199-010-0586-2
  7. Kehoe T.J., Ruhl K.J.: Sudden stops, sectoral reallocations, and the real exchange rate. J. Dev. Econ. 89, 235–249 (2009)CrossRefGoogle Scholar
  8. Krasa S., Sharma T., Villamil A.P.: Bankruptcy and firm finance. Econ. Theory 36(2), 239–266 (2008)CrossRefGoogle Scholar
  9. Krugman P.R.: A model of balance-of-payments crises. J. Money Credit Bank. 11, 311–325 (1979)CrossRefGoogle Scholar
  10. Krugman P.R.: Are Currency Crises Self-Fulfilling?. In: Bernanke, B.S., Rotemberg, J.J. (eds) NBER Macroeconomics annual, pp. 345–378. MIT Press, Cambridge (1996)Google Scholar
  11. Kydland F.E., Zarazaga C.E.J.: Argentina’s lost decade. Rev. Econ. Dyn. 5, 152–165 (2002)CrossRefGoogle Scholar
  12. Obstfeld M.: Rational and self-fulfilling balance-of-payments crises. Am. Econ. Rev. 76, 72–81 (1986)Google Scholar
  13. Obstfeld M.: Models of currency crises with self-fulfilling features. Eur. Econ. Rev. 40, 1037–1047 (1996)CrossRefGoogle Scholar
  14. Pastine I.: Devaluation of fixed exchange rates: optimal strategy in the presence of speculation. Econ. Theory 15(3), 631–661 (2000)CrossRefGoogle Scholar
  15. Perry, G., Serven, L.: The Anatomy of a Multiple Crisis : Why was Argentina Special and What Can We Learn from it? World Bank Policy Research Working Paper 3081 (2003)Google Scholar
  16. Reis, C.: Taxation without commitment. Econ. Theory (2011). doi: 10.1007/s00199-011-0656-0
  17. Sachs J., Tornell A., Velasco A.: The Mexican peso crisis: sudden death or death foretold?. J. Int. Econ. 41, 265–283 (1996)CrossRefGoogle Scholar
  18. Schmitt-Grohe S., Uribe M.: Closing small open economy models. J. Int. Econ. 61, 163–185 (2003)CrossRefGoogle Scholar
  19. Yu, Z.: Openness, managerial incentives, and heterogeneous firms. Econ. Theory (2010). doi: 10.1007/s00199-010-0595-1

Copyright information

© Springer-Verlag 2012

Authors and Affiliations

  • José-María Da-Rocha
    • 1
    • 2
  • Eduardo-Luis Giménez
    • 1
  • Francisco-Xavier Lores
    • 3
  1. 1.Departamento de Fundamentos da Análise EconomicaUniversidade de VigoVigoSpain
  2. 2.Departament d’Economia i d’Història EconòmicaUniversitat Autònoma de BarcelonaBellaterra (Cerdanyola del Vallès)Spain
  3. 3.Departamento de Fundamentos da Análise EconomicaUniversidade de Santiago de CompostelaSantiago de CompostelaSpain

Personalised recommendations