Gambling for Redemption and Self-Fulfilling Debt Crises
We develop a model for analyzing the sovereign debt crises of 2010–2013 in the Eurozone. The government sets its expenditure-debt policy optimally. The need to sell large quantities of bonds every period leaves the government vulnerable to self-fulfilling crises in which investors, anticipating a crisis, are unwilling to buy the bonds, thereby provoking the crisis. In this situation, the optimal policy of the government is to reduce its debt to a level where crises are not possible. If, however, the economy is in a recession where there is a positive probability of recovery in fiscal revenues, the government may optimally choose to “gamble for redemption,” running deficits and increasing its debt, thereby increasing its vulnerability to crises.
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Copy CitationJuan Carlos Conesa and Timothy J. Kehoe, "Gambling for Redemption and Self-Fulfilling Debt Crises," NBER Working Paper 21026 (2015), https://doi.org/10.3386/w21026.
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Published Versions
Juan Carlos Conesa & Timothy J. Kehoe, 2017. "Gambling for redemption and self-fulfilling debt crises," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 64(4), pages 707-740, December. citation courtesy of 
Juan Carlos Conesa & Timothy J. Kehoe, 2017. "Gambling for redemption and self-fulfilling debt crises," Economic Theory, vol 64(4), pages 707-740.
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