Faculty of Business and Economics
University of Lausanne
Institutional Affiliation: University of Lausanne
NBER Working Papers and Publications
|May 2015||Self-Fulfilling Debt Crises: Can Monetary Policy Really Help?|
with Philippe Bacchetta, Eric van Wincoop: w21158
This paper examines quantitatively the potential for monetary policy to avoid self-fulfilling sovereign debt crises. We combine a version of the slow-moving debt crisis model proposed by Lorenzoni and Werning (2014) with a standard New Keynesian model. We consider both conventional and unconventional monetary policy. Under conventional policy the central bank can preclude a debt crisis through inflation, lowering the real interest rate and raising output. These reduce the real value of the outstanding debt and the cost of new borrowing, and increase tax revenues and seigniorage. Unconventional policies take the form of liquidity support or debt buyback policies that raise the monetary base beyond the satiation level. We find that generally the central bank cannot credibly avoid a self-fulf...