Skip to main content


  • Falko Juessen (a1), Ludger Linnemann (a2) and Andreas Schabert (a3)

We develop a macroeconomic model in which the government does not guarantee to repay debt. We ask whether movements in the price of government bonds can be rationalized by lenders' unwillingness to fully roll over debt when the outstanding level of debt exceeds the government's repayment capacity. Investors do not support a Ponzi game in this case, but ration credit supply, thus forcing default at an endogenously determined fractional repayment rate. Interest rates on government bonds reflect expectations of this event. Numerical results show that default premia can emerge at moderately high debt-to-GDP ratios where even small changes in fundamentals lead to steeply rising interest rates. The behavior of risk premia broadly accords with recent observations for several European countries that experienced a worsening of fundamental fiscal conditions.

Corresponding author
Address correspondence to: Andreas Schabert, University of Cologne, Center for Macroeconomic Research, Albertus-Magnus-Platz, 50923 Cologne, Germany; e-mail:
Hide All
Arellano, Cristina (2008) Default risk and income fluctuations in emerging economies. American Economic Review 98, 690712.
Auerbach, Alan J., Gokhale, Jagadeesh, and Kotlikoff, Laurence J. (1994) Generational accounting: A meaningful way to evaluate fiscal policy. Journal of Economic Perspectives 8, 7394.
Bi, Huixin (2012) Sovereign default risk premia, fiscal limits, and fiscal policy. European Economic Review 56, 389410.
Bi, Huixin and Leeper, Eric (2012) Analyzing Fiscal Sustainability. Unpublished manuscript, Indiana University.
Bohn, Henning (1998) The behavior of U.S. public debt and deficits. Quarterly Journal of Economics 113, 949963.
Daniel, Betty C. and Shiamptanis, Christos (2012) Fiscal risk in a monetary union. European Economic Review 56, 12891309.
D'Erasmo, Pablo and Mendoza, Enrique G. (2013) Distributional incentives in an equilibrium model of domestic sovereign default. NBER working paper 19477.
Eaton, Jonathan and Gersovitz, Mark (1981) Debt with potential repudiation: Theoretical and empirical analysis. Review of Economic Studies 47, 289309.
Evans, Richard W., Kotlikoff, Lawrence J., and Phillips, Kerk L. (2013) Game over: Simulating unsustainable fiscal policy. In Alesina, A. and Giavazzi, F. (eds.), Fiscal Policy After the Financial Crisis, pp. 177202. Chicago: University of Chicago Press.
Lorenzoni, Guido and Werning, Ivan (2013) Slow Moving Debt Crises. Unpublished manuscript, Northwestern University.
Mendoza, Enrique G. and Yue, Vivian Z. (2012) A general equilibrium model of sovereign default and business cycles. Quarterly Journal of Economics 127, 889946.
Reinhart, Carmen and Rogoff, Kenneth (2008) The Forgotten History of Domestic Debt. NBER working paper 13946.
Schabert, Andreas (2010) Monetary policy under a fiscal theory of sovereign default. Journal of Economic Theory 145, 860868.
Sims, Christopher (1994) A simple model for the study of the determination of the price level and the interaction of monetary and fiscal policy. Economic Theory 4, 381399.
Tauchen, George (1986) Finite state Markov-chain approximation to univariate and vector autoregressions. Economics Letters 20, 177181.
Uribe, Martin (2006) A fiscal theory of sovereign risk. Journal of Monetary Economics 53, 18571875.
Woodford, Michael (1994) Monetary policy and price level determinacy in a cash-in-advance economy. Economic Theory 4, 345380.
Recommend this journal

Email your librarian or administrator to recommend adding this journal to your organisation's collection.

Macroeconomic Dynamics
  • ISSN: 1365-1005
  • EISSN: 1469-8056
  • URL: /core/journals/macroeconomic-dynamics
Please enter your name
Please enter a valid email address
Who would you like to send this to? *



Full text views

Total number of HTML views: 0
Total number of PDF views: 0 *
Loading metrics...

Abstract views

Total abstract views: 0 *
Loading metrics...

* Views captured on Cambridge Core between <date>. This data will be updated every 24 hours.

Usage data cannot currently be displayed