Bubbles and Self-Enforcing Debt
Author(s)Hellwig, Christian; Lorenzoni, Guido
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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.
DepartmentMassachusetts Institute of Technology. Department of Economics
Econometrica : journal of the Econometric Society
Hellwig, Christian, and Guido Lorenzoni. “Bubbles and Self-Enforcing Debt.” Econometrica 77.4 (2009): 1137-1164.
Author's final manuscript