Econometrica: Jul 2009, Volume 77, Issue 4

Bubbles and Self‐Enforcing Debt
p. 1137-1164

Christian Hellwig, Guido Lorenzoni

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.

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Supplemental Material

Supplement to "Bubbles and Self-Enforcing Debt"

This file presents three extensions of the example in Section 3.

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