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Collateral, Liquidity and Debt Sustainability

Niemann, S and Pichler, P (2017) 'Collateral, Liquidity and Debt Sustainability.' The Economic Journal, 127 (604). 2093 - 2126. ISSN 0013-0133

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Abstract

We study Markov‐perfect optimal fiscal policy in an economy with financial frictions and sovereign default in the form endogenously determined haircuts on outstanding debt. Government bonds facilitate tax smoothing but also provide collateral and liquidity services that mitigate financial frictions. A debt Laffer curve exists, which induces the government to issue bonds to a point where marginal debt has negative welfare effects. Debt positions in the order of magnitude of annual output remain sustainable despite the option to default. When default happens, liquidity on the bond market is impaired, which can trigger extended periods of recurrent haircuts.

Item Type: Article
Subjects: H Social Sciences > HB Economic Theory
Divisions: Faculty of Social Sciences > Economics, Department of
Depositing User: Stefan Niemann
Date Deposited: 27 Jun 2016 09:19
Last Modified: 06 Jul 2018 13:15
URI: http://repository.essex.ac.uk/id/eprint/17048

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