Sustainable debt

Abstract

We show that debt is sustainable at a competitive equilibrium based solely on the reputation for repayment; that is, even without collateral or legal sanctions available to creditors. In an incomplete asset market, when the rate of interest falls recurrently below the rate of growth of the economy, self‐insurance is more costly than borrowing, and repayments on loans are enforced by the implicit threat of loss of the risk‐sharing advantages of debt contracts. Private debt credibly circulates as a form of inside money, and it is not valued as a speculative bubble. Competitive equilibria with self‐enforcing debt exist under a suitable hypothesis of gains from trade.

Sovereign Debt Crises and Low Interest Rates

“…In Bloise et al (2021) we study the competitive equilibrium of an economy with limited commitment in which debts are not secured by collateral or legal sanctions. Default only entails a loss of the reputation for repayment, inducing a consequent inability to borrow in the future.…”

“…Thus, we estimate the long-term interest rate, net of growth, by considering the Perron-Frobenius dominant root of the valuation functional. A fully developed theory is provided by Bloise et al (2017Bloise et al ( , 2021 (see also Appendix B). Here we only present the relevant restriction on the pricing kernel and an informal discussion.…”