Bubbles and Self-Enforcing Debt

We characterize equilibria with endogenous debt constraints for a general equilibrium economy with limited commitment in which the only consequence of default is losing the ability to borrow in future periods. First, we show that equilibrium debt limits must satisfy a simple condition that allows ag...

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Bibliographic Details
Published in:Econometrica 2009-07, Vol.77 (4), p.1137-1164
Main Authors: Hellwig, Christian, Lorenzoni, Guido
Format: Article
Language:English
Subjects:
Allocations
Applications
Biology, psychology, social sciences
Commitments
Debt
Debt limits
Debt repayment
Economic bubbles
Economic theory
Economics
Endowments
Equilibrium
Equilibrium models
Equilibrium theory
Exact sciences and technology
External debt
General economic equilibrium
Insurance, economics, finance
Interest rates
Loan defaults
Mathematics
Probability and statistics
Probability theory and stochastic processes
Public debt
rational bubbles
Risk sharing
Sciences and techniques of general use
Self-enforcing debt
sovereign debt
Special processes (renewal theory, markov renewal processes, semi-markov processes, statistical mechanics type models, applications)
Statistics
Studies
Sustainable economies
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Description
Summary:We characterize equilibria with endogenous debt constraints for a general equilibrium economy with limited commitment in which the only consequence of default is losing the ability to borrow in future periods. First, we show that equilibrium debt limits must satisfy a simple condition that allows agents to exactly roll over existing debt period by period. Second, we provide an equivalence result, whereby the resulting set of equilibrium allocations with self-enforcing private debt is equivalent to the allocations that are sustained with unbacked public debt or rational bubbles. In contrast to the classic result by Bulow and Rogoff (1989a), positive levels of debt are sustainable in our environment because the interest rate is sufficiently low to provide repayment incentives.
ISSN:0012-9682
1468-0262
DOI:10.3982/ECTA6754