https://macropaperwarehouse.com/authors/gaston-navarro/Gaston NavarroHugo -- gohugo.ioen-ushttps://macropaperwarehouse.com/papers/self-fulfilling-debt-crises-with-long-stagnations/https://macropaperwarehouse.com/papers/self-fulfilling-debt-crises-with-long-stagnations/<p>This paper asks whether sovereign debt crises can be self-fulfilling — triggered by lenders&rsquo; expectations of default rather than by weak fiscal fundamentals alone — and whether such crises are empirically plausible. Following the mechanism of Calvo (1988), high expected default probabilities require high interest rates to compensate lenders, but high interest rates in turn raise the cost of debt service and the probability of default, making the pessimistic expectations self-confirming. The key theoretical contribution is to show that this multiplicity of equilibria is state-dependent: it arises only in periods of stagnation, when the endowment process is in a persistent low-growth regime. The paper modifies a standard infinite-horizon sovereign default model (in the spirit of Eaton-Gersovitz and Arellano 2008) by introducing a two-state Markov regime-switching process for trend growth and by having the borrower choose current debt rather than debt at maturity — a timing assumption that is essential for multiplicity. Calibrating the output process to Argentina, Brazil, Italy, Portugal, and Spain using 1980–2017 data, the paper finds that for intermediate levels of debt and in low-growth states, interest rates can be either low (around 4%) or high (around 46%) depending on the coordination of lenders&rsquo; beliefs — a self-fulfilling crisis range that reproduces the qualitative features of the European sovereign debt crisis of 2010–2012 and the Argentine crisis of 1998–2002. In high-growth states, the multiplicity region is negligibly small or absent entirely.</p>