Research Insights: What Is the Role of Market Expectations in Sovereign Debt Crises?

Fluctuations in bond spreads that are simply due to pessimistic market expectations are more prone to happen in countries that face the risk of long periods of economic stagnation. The quantitative results attribute an important role to pessimistic market expectations in the debt crisis in Argentina in 2001 but not in the debt crisis in Spain in 2012. Policy interventions such as a lender of last resort can avoid self-fulfilling debt crisis at very low cost. These interventions are necessary (but not sufficient) when countries display bad economic fundamentals, and their benefits are larger if creditors anticipate them.