Debt Crises, Fast and Slow

We build a dynamic model to study how shifts in investors’ beliefs can drive either slow-moving debt crises or rollover crises. We show that the threat of slow-moving crises does not necessarily motivate deleveraging: in a recession, unless debt is close enough to the threshold at which the economy becomes vulnerable to such crises, optimizing governments keep borrowing, gambling on economic recovery. The incentive to deleverage is instead strong when the economy is vulnerable to rollover crises at low levels of debt. We show that equilibrium multiplicity remains pervasive independently of bond maturity. In general, short maturities induce more deleveraging.