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

Abstract

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.

Keywords

Default Devaluation Self-fulfilling crisis 

JEL Classification

E6 F3 F34 

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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

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