The Economics of Public Debt

Course description
The surge of public debt in the wake of the crisis has led to doubts about the efficacy of deficit spending, and triggered fears about the negative consequences of excessive levels of public debt. At the same time, the financial-deepening that characterizes the developed economies has brought to attention the key role played by “safe assets” in the credit/investment process and the role that public debt securities play in offsetting the scarcity of safe assets that the private sector can effectively generate. This challenges the proposition of Ricardian Equivalence. Moreover a recent strand of literature empirically funded and theoretically developed claims that sovereign debt securities play the role of “quasi money” and are necessary for financial stability and growth. With reference to the EU, it provides the economically funded background for euro-bonds. This course covers these topics focusing on the questions that are open to theoretical and empirical analysis.

Topics

  • Ricardian equivalence
  • Debt sustainability
  • Monetary dominance and fiscal challenges
  • Financial deepening and the role of sovereign debt:
    • Private and public supply of liquidity
    • Safe asset scarcity
    • Government debt securities as “quasi money”: Theory and evidence
  • The interrelations between sovereign debt, banks and credit
  • Focus on the Eurozone sovereign debt markets and crisis: sustainability, vulnerability, sudden stops: lessons from history and the international finance literature.

Learning outcomes
At the end of the course, students should have acquired sufficient knowledge to understand and model the interactions between sovereign debt and the macro-economy and to formulate a cutting-edge research question in a proposal and carrying out the proposed research.

Teaching methods
For each topic there will be first regular lecturing illustrating the issues and the modeling, and then assigned readings to students so as to enable effective participation in classroom discussions, the assessment of articles’ marginal contributions and the identification of the questions/issues that are open to further analysis.

Assessment methods

  • The presentation of a recent paper chosen from the reading list (20%);
  • The writing of a “referee report” that (i) summarizes the main economic insights of the paper without repeating the technicalities, (ii) evaluates what the marginal contribution is and whether it buys the results, and (iii) provides a constructive critique of what could/should be improved, e.g. what assumptions are questionable, what methodologies should be reassessed etc. (30%);
  • A research proposal, or as an alternative an essay on a issueagreed with the Instructor (50%). The research proposal should include (i) an abstract that captures the central idea of the proposal, (ii) a detailed introduction that explains why the research question is important and relevant and what is the marginal contribution to the existing literature. It should cover the following: for an empirical paper, what data are needed, where to get it from, and what regressions will be run (with a few sample equations). If it isfora theoretical paper, include a model setup, and describe what results should be expected.

Syllabus

Ricardian equivalence, Debt Sustainability, monetary dominance and fiscal challenges:

  • Barro, R.J. (1974), “Are Government Bonds Net Wealth?”, Journal of Political Economy 82, 1095-1117
  • Sargent,T.J.,and N.Wallace.(1981),”Some Unpleasant Monetarist Arithmetic.” Federal Reserve Bank of Minneapolis Quarterly Review 5, pp 1{17
  • Uribe, M. (2006), “A Fiscal Theory of Sovereign Risk”, Journal of Monetary Economics 53, pp. 1857-1875
  • Jeanne, O. (2012), “Fiscal Challenges to Monetary Dominance in the Euro Area: a Theoretical Perspective”, Banque de France,FinancialStability Review, No. 16, April 2012
  • Corsetti, Giancarlo, Keith Kuester, Andre ́ Meier, and Gernot Mu ̈ller. 2012. “Sovereign Risk, Fiscal Policy, and Macroeconomic Stability”. CEPR Discussion Paper 8779
  • Calvo, Guillermo A. (1988), “Servicing the Public Debt: The Role of Expectations,” American Economic Review 78(4), pp. 647-661
  • Cole, Harold L. and Timothy J. Kehoe (1996), “A Self-Fulfilling Model of Mexico’s 1994-1995 Debt Crisis,” Journal of International Economics 41(3-4), pp. 309-330
  • Cole, Harold L. and Timothy J. Kehoe (2000), “Self-Fulfilling Sovereign Debt Crises”, Review of Economic Studies 67(1), pp. 91-116
  • Ugo Panizza, Federico Sturzenegger and Jeromin Zettelmeyer (2009), “The Economics and Law of Sovereign Debt and Default”, Journal of Economic Literature 47(3), pp. 651–98
  • Roch, Francisco and Harald Uhlig (2012), “The Dynamics of Sovereign Debt Crises and Bailouts”, mimeo.


Financial-deepening and the role of sovereign debt:

  • Background: Holmstrom, B., and J.Tirole (1998), “Private and Public Supply of Liquidity”, Journal of Political economy 106, 1-40
  • Holmstrom, B., and J.Tirole (2011), “nsideand Outside Liquidity”, MIT Press. Tirole, J. (2006), Theory of Corporate Finance, Princeton University press, 2006 – Chapter 15
  • Woodford, M. (1990), “Public Debt as Private Liquidity”, American Economic Review 80, pp.382-388
  • Farhi, E. and J. Tirole (2012), “Bubbly Liquidity”, Review of Economic Studies 79, pp. 678–706
  • Bolton, P. and O. Jeanne (2011), “Sovereign Default Risk and Bank Fragility in Financially Integrated Economies”, NBER W. P. 16899
  • Krishnamurthy, A. and A. Vissing-Jorgensen (2012), “The Aggregate Demand for Treasury Debt”, Journal of Political Economy 120, 233-267
  • Chiesa, G. (2013),“Safe Assets’ Scarcity, Liquidity and Spreads”, DSE WP.
  • Gourinchas, P.O. and O. Jeanne (2012), “Global Safe Assets”, BIS WP n. 399

 

Public Debt, Banks, and Credit

  • Jorda, O., M. Schularick and A.M. Taylor, (2013) “Sovereigns versus Banks: Credit, Crises, and Consequences”, Federal Reserve Bank of San Francisco, Working Paper Series, 2013–37
  • Bofondi, M, L. carpinelliand E. Sette (2013), “ Credit Supply During a Sovereign Debt Crisis”, Bank of Italy WP N. 909
  • Mallucci, Enrico (2013) “Sovereign Defaults, Wholesale Funding and Banking Crises” LSE WP
  • De Marco, Filippo (2014) “Bank Lending and the Sovereign Debt Crisis” ,WP

 

Focus on the Eurozone sovereign debt markets and crisis:

  • Cameron, David R. (2011) ”The Eurozone Crisis: Stumbling toward Economic Government”, Yale universityWP
  • Arslanalp, S. and T. Takahiro (2012), “Tracking Global Demand for Advanced Economy Sovereign Debt”, IMF WP /12/284
  • De Marco, F. and Macchiavelli, M., (2014) “The Political Origin of Home Bias: the case of Europe”, Working Paper
  • Battistini, N. ,M. Pagano e S. Simonelli (2013), “Systemic Risk, Sovereign Yields and Bank Exposures in the Euro Crisis”, CSEF WP N.345
  • Krugman, P. (2013), “Currency Regimes, Capital Flows, and Crises”, IMF (14th Jacques Polack Annual Research Conference, 2013)
  • Lorenzoni, G. and I. Werning (2013), “Slow Moving Debt Crises”, Northwestern University WP