Does Government Insolvency Imply Speculative Attacks?

17 Pages Posted: 24 Apr 2013

Date Written: September 1995

Abstract

The aim is to show how and when government insolvency implies a fixed exchange rate regime crisis. To model these issues I try to unify a stylized macroeconomic model with a standard micro agent behavior toward asset pricing. The equilibrium condition between demand and supply of public debt, the latter coming from the current government budget constraint, shows the vitious circle between debt accumulation, default probabilities and interest payments. In this set up, the Treasury crisis is shown to be driven by two interdependent processes: (i) the rate at which the public debt stock accumulates; (ii) the rate at which the likelihood of default increases, which affects the domestic real interest rate. When the two processes lead debt to accumulate at a rate faster than r, debt accumulates at an increasing rate that reaches infinity in finite time. Under this kind of circumstance, the impossibility to offer the equilibrium return develops the run. An increasing second derivative of debt accumulation process is seen as a possible psycological threshold, that used as signal of default, may start the vitious spiral.

Keywords: speculative attacks, public debt, unsustainability, balance of payments crisis, run, Bayes, bayesian, fiscal policy, monetary policy, inflationary policy

JEL Classification: E42, E44, E52, E58, F34, F41, G15, H63

Suggested Citation

Miceli, Maria-Augusta, Does Government Insolvency Imply Speculative Attacks? (September 1995). Available at SSRN: https://ssrn.com/abstract=2255752 or http://dx.doi.org/10.2139/ssrn.2255752

Maria-Augusta Miceli (Contact Author)

University of Rome Sapienza ( email )

Dept. of Economics and Law
9, Via del Castro Laurenziano
Rome, Rome 00161
Italy

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