Self-Fulfilling Debt Crises with Long Stagnations

Joao Ayres, Inter-American Development Bank

Gaston Navarro, Federal Reserve Board

Juan Pablo Nicolini, Senior Research Economist

Pedro Teles, Banco de Portugal, Catolica Lisbon SBE, and CEPR

April 2019| Federal Reserve Bank of Minneapolis Working Paper 757

We explore quantitatively the possibility of multiple equilibria in a model of sovereign debt crises. The source of multiplicity is the one identified by Calvo (1988). This type of multiplicity has been at the heart of the policy debate through the recent European sovereign debt crisis. Key for multiplicity in the model is a stochastic process for output featuring long periods of either high or low growth. We calibrate the output process in the model using data for the southern European countries that were exposed to the debt crisis. We find that expectations-driven sovereign debt crises are empirically plausible, but only in periods of stagnation. Multiplicity is state dependent: in periods of stagnation and for intermediate levels of debt, interest rates may be high for reasons unrelated to fundamentals.