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Preventing Self-Fulfilling Debt Crises: A Global Games Approach

Author

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  • Michal Szkup

    (University of British Columbia)

Abstract
This paper develops a micro-founded global games model of debt crises. I use this model to study which policies can help to prevent expectations-driven crises and how the desirability of such policies depends on market participants' expectations and the presence of economic policy uncertainty. I show that endogenous expectations amplify the effects of government policies, so that even a small policy adjustment can have significant effects. I find that policy uncertainty may increase the range of situations in which government policies can help prevent a crisis but decrease their overall impact. Finally, I apply these insights to study two policies that are often at the center of political discussions: austerity (an increase in taxes) and government stimulus. I show that under plausible conditions an increase in taxes is preferable to a government stimulus, and that policy uncertainty further increases the relative attractiveness of austerity. (Copyright: Elsevier)

Suggested Citation

  • Michal Szkup, 2022. "Preventing Self-Fulfilling Debt Crises: A Global Games Approach," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 43, pages 22-55, January.
    • Handle: RePEc:red:issued:19-127
    DOI: 10.1016/j.red.2020.12.002
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    More about this item

    Keywords

    Sovereign debt crises; Global games; Expectations; Policy uncertainty; Taxes; Stimulus;
    All these keywords.

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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