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A self-fulfilling model of Mexico's 1994-95 debt crisis
This paper explores the extent to which the Mexican government's inability to roll over its debt during December 1994 and January 1995 can be modeled as a self-fulfilling debt crisis. In the model there is a crucial interval of debt for which the government, although it finds it optimal to repay old debt if it can sell new debt, finds it optimal to default if it cannot sell new debt. If government debt is in this interval, which we call the crisis zone, then we can construct equilibria in which a crisis can occur stochastically, depending on the realization of a sunspot variable. The size of ...
Report
Dynamic games with hidden actions and hidden states
We consider a class of dynamic games in which each player?s actions are unobservable to the other players and each player?s actions can influence a state variable that is unobservable to the other players. We develop an algorithm that solves for the subset of sequential equilibria in which equilibrium strategies depend on private information only through the privately observed state.
Working Paper
Self-Fulfilling Debt Crises, Revisited
We revisit self-fulfilling rollover crises by exploring the potential uncertainty introduced by a gap in time (however small) between an auction of new debt and the payment of maturing liabilities. It is well known (Cole and Kehoe, 2000) that the lack of commitment at the time of auction to repayment of imminently maturing debt can generate a run on debt, leading to a failed auction and immediate default. We show that the same lack of commitment leads to a rich set of possible self-fulfilling crises, including a government that issues more debt because of the crisis, albeit at depressed ...
Journal Article
Direct investment: a doubtful alternative to international debt
The paper considers a model in which private foreign investors make direct long-lived capital investments in a small developing country that is subject to stochastic shocks to production. Depending upon the preferences of the host country, we find that expropriation can occur because of either desperation or opportunism. We show that under reasonable assumptions, increased investment makes expropriation less likely to occur and that the level of investment chosen by atomistic foreign investors may be nonoptimal.
Working Paper
Self-Fulfilling Debt Crises, Revisited: The Art of the Desperate Deal
We revisit self-fulfilling rollover crises by introducing an alternative equilibrium selection that involves bond auctions at depressed but strictly positive equilibrium prices, a scenario in line with observed sovereign debt crises. We refer to these auctions as ?desperate deals?, the defining feature of which is a price schedule that makes the government indifferent to default or repayment. The government randomizes at the time of repayment, which we show can be implemented in pure strategies by introducing stochastic political payoffs or external bailouts. Quantitatively, auctions at ...
Report
Re-examining the contributions of money and banking shocks to the U.S. Great Depression
This paper quantitatively evaluates the hypothesis that deflation can account for much of the Great Depression (1929?33). We examine two popular explanations of the Depression: (1) The ?high wage? story, according to which deflation, combined with imperfectly flexible wages, raised real wages and reduced employment and output. (2) The ?bank failure? story, according to which deflationary money shocks contributed to bank failures and to a reduction in the efficiency of financial intermediation, which in turn reduced lending and output. We evaluate these stories using general equilibrium ...
Working Paper
New Deal policies and the persistence of the Great Depression: a general equilibrium analysis
There are two striking aspects of the recovery from the Great Depression in the United States: the recovery was very weak and real wages in several sectors rose significantly above trend. These data contrast sharply with neoclassical theory, which predicts a strong recovery with low real wages. We evaluate the contribution of New Deal cartelization policies designed to limit competition and increase labor bargaining power to the persistence of the Depression. We develop a model of the bargaining process between labor and firms that occurred with these policies, and embed that model within a ...
Journal Article
Incorporating concern for relative wealth into economic models
This article develops a simple model that captures a concern for relative standing, or status. This concern is instrumental, in the sense that individuals do not get utility directly from their relative standing, but, rather, the concern is induced because their relative standing affects their consumption of standard commodities. The article investigates the consequences of a concern for relative wealth in models in which individuals are making labor/leisure decisions. The analysis shows how individuals' decisions are affected by the aggregate income distribution and how the concern for ...
Report
Self-fulfilling debt crises
We characterize the values of government debt and the debt's maturity structure under which financial crises brought on by a loss of confidence in the government can arise within a dynamic, stochastic general equilibrium model. We also characterize the optimal policy response of the government to the threat of such a crisis. We show that when the country's fundamentals place it inside the crisis zone, the government is motivated to reduce its debt and exit the crisis zone because this leads to an economic boom and a reduction in the interest rate on the government's debt. We show that this ...