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The Domestic Debt Intolerance and Bad Equilibrium: An Empirical Default Model

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  • Ozkaya, Ata

    (Galatasaray University Economic Research Center)

Abstract

The Turkish financial crises 1994 and 2000-2001 are spaced some years apart, creating an illusion that this time is different among policymakers and investors. Suppose that the dynamics of the macroeconomy generates multiple values for the domestic interest rate premium : "low" and "high". The sudden shifts in financial markets that characterize financial crises are then interpreted as a shift from one equilibrium to another. In this paper, we specify a dynamic model in which debt default through inflation is possible, determine its closed-form solution and multiple equilibria. We estimate the model using the properties of chaos theory, against post-liberalization period (1989-2010) data for Turkey. The problem takes as given our model economy with multiple equilibria and asks whether the multiple equilibria can be verified by the data. To make progress on this problem we introduce phase-space portrait of the considered economy and identify path for debt dynamics moving from low and diverging through high interest levels. Second, we measure how the default episodes 1994 and 2000-2001 converge/diverge apart on phase-space, depending on the maximal Lyapunov exponent. Since the data show support for the multiple-equilibrium explanation of the serial defaults, we better understand the significance of domestic debt behind the high inflation, banking crises and currency crashes that Turkish economy frequently experienced in its postliberalization period.

Suggested Citation

  • Ozkaya, Ata, 2013. "The Domestic Debt Intolerance and Bad Equilibrium: An Empirical Default Model," GIAM Working Papers 13-1, Galatasaray University Economic Research Center.
    • Handle: RePEc:ris:giamwp:2013_001
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    References listed on IDEAS

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    More about this item

    Keywords

    Defaults; Multiple equilibria; Phase-space; Lyapunov exponent; Interest rates; Turkish financial crises;
    All these keywords.

    JEL classification:

    • C65 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Miscellaneous Mathematical Tools
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • O52 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies - - - Europe

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