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Credit Markets, Limited Commitment, and Government Debt

Author

Listed:
  • Stephen Williamson

    (Washington University in St. Louis)

  • Francesca Carapella

    (Board of Governors of the Federal Reserv)

Abstract

A model of credit and government debt with limited commitment is constructed, building on a Lagos-Wright construct. In the baseline equilibrium, global punishments support an efficient equilibrium in which government debt is neutral - there is Ricardian equivalence. In a symmetric equilibrium with individual punishments, trade in government debt essentially always serves to increase welfare by altering the incentive to default. In asymmetric equilibria, all borrowers are fundamentally identical, but some default in equilibrium, there is an adverse selection problem in a segment of the credit market, and good borrowers pay a default premium. Government debt, in addition to altering the incentive to default, serves to mitigate the adverse selection problem. Thus, government debt relaxes incentive constraints, working through an endogenous collateral effect. The model highlights the role of government debt in helping to solve the problem of a self-fulfilling breakdown in credit markets.

Suggested Citation

  • Stephen Williamson & Francesca Carapella, 2012. "Credit Markets, Limited Commitment, and Government Debt," 2012 Meeting Papers 226, Society for Economic Dynamics.
    • Handle: RePEc:red:sed012:226
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    Cited by:

    1. Lee, Seungduck, 2016. "Money, Asset Prices and the Liquidity Premium," MPRA Paper 74010, University Library of Munich, Germany.
    2. Wang, Zijian, 2020. "Liquidity and private information in asset markets: To signal or not to signal," Journal of Economic Theory, Elsevier, vol. 190(C).
    3. Ohik Kwon & Manjong Lee, 2024. "Credit Market Frictions and Coessentiality of Money and Credit," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 56(1), pages 257-278, February.
    4. Lee, Seungduck, 2016. "Money, Asset Prices and the Liquidity Premium," MPRA Paper 73707, University Library of Munich, Germany.
    5. Chao Gu & Fabrizio Mattesini & Randall Wright, 2016. "Money and Credit Redux," Econometrica, Econometric Society, vol. 84, pages 1-32, January.
    6. Lee, Seungduck, 2016. "Money, Asset Prices and the Liquidity Premium," MPRA Paper 73533, University Library of Munich, Germany.
    7. Pierre Yared & Marina Azzimonti, 2017. "The Public and Private Provision of Safe Assets," 2017 Meeting Papers 755, Society for Economic Dynamics.
    8. Carli, Francesco & Gomis-Porqueras, Pedro, 2021. "Real consequences of open market operations: The role of limited commitment," European Economic Review, Elsevier, vol. 132(C).
    9. Kiyotaki, Nobuhiro & Lagos, Ricardo & Wright, Randall, 2016. "Introduction to the symposium issue on money and liquidity," Journal of Economic Theory, Elsevier, vol. 164(C), pages 1-9.
    10. Chao He & Randall Wright & Yu Zhu, 2015. "Housing and Liquidity," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(3), pages 435-455, July.
    11. Fabienne Schneider & Remo Taudien, 2024. "Credit and Anonymity," Working Papers 24.04, Swiss National Bank, Study Center Gerzensee.
    12. Bethune, Zachary & Hu, Tai-Wei & Rocheteau, Guillaume, 2018. "Indeterminacy in credit economies," Journal of Economic Theory, Elsevier, vol. 175(C), pages 556-584.
    13. Azzimonti, Marina & Yared, Pierre, 2019. "The optimal public and private provision of safe assets," Journal of Monetary Economics, Elsevier, vol. 102(C), pages 126-144.
    14. Francesca Carapella, 2017. "Credit markets, Limited commitment and Optimal monetary policy," 2017 Meeting Papers 1523, Society for Economic Dynamics.
    15. Lee, Seungduck, 2016. "Money, Asset Prices and the Liquidity Premium," MPRA Paper 74615, University Library of Munich, Germany.
    16. Lee, Seungduck, 2016. "Money, Asset Prices and the Liquidity Premium," MPRA Paper 75869, University Library of Munich, Germany.
    17. Athanasios Geromichalos & Jiwon Lee & Seungduck Lee & Keita Oikawa, 2016. "Over-the-counter trade and the value of assets as collateral," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 62(3), pages 443-475, August.
    18. Kee-Youn Kang, 2023. "Cryptocurrency and double spending history: transactions with zero confirmation," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 75(2), pages 453-491, February.

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    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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