Abstract
This paper shows that under certain conditions highly indebted countries could fall into a low credibility trap. This occurs when a government is judged not to be credible by financial markets. It then has to pay a risk premium in terms of higher interest rates. The higher debt service burden that results, if inflation is kept low, makes it even more likely that the authorities will abandon the attempt to stabilize and try to reduce the real value of the debt through a surprise inflation, hence this further increases the risk premium demanded by financial markets, possibly leading to a spiral of increasing interest rates until the government caves in.
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© 1998 Springer Science+Business Media New York
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Gros, D. (1998). Self-Fulfilling Public Debt Crises. In: Rehman, S.S. (eds) Financial Crisis Management in Regional Blocs. Springer, Dordrecht. https://doi.org/10.1007/978-94-011-4864-1_14
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DOI: https://doi.org/10.1007/978-94-011-4864-1_14
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