Self-Fulfilling debt crises and the role of short-sighted optimal policy

Scholar: Lennart Niermann

Scholarship Period: 2023 - 2025

My research investigates why countries end up at a disadvantageous point of high debt and high economic costs of default. In a theoretical framework, I find that governments optimally use a shift towards more painful debt portfolios to momentarily rule out liquidity crises and even permanently increase debt levels. Empirically, I find evidence for such a commitment channel as I find that a one percentage point increase in creditors' expected recovery rate reduces markets' beliefs about the likelihood of a default event over the next year by 0.27 percentage points.