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Krugman's 'honeymoon' seminal paper showed in 1991 the stabilizing properties of the adoption of fluctuation bands and gave rise to the literature on target zones. Subsequent contributions, however, showed that, in the absence of adequate reserves, a destabilizing 'divorce' would lead to speculative attacks. The euro area public debt crisis revived that literature, producing a second generation of target zone modeling, based on the idea that the sustainability of public debt implies the adoption of an interest rate target. Its lack of credibility (if the central bank or the government does not guarantee repayment of the debt) explains the non-linearity of the relationship between interest rates and public debt that was observed during the euro area crisis. The model also makes it possible to understand why some non-euro area countries have not been subject to speculative attacks despite the fact that their public debt-to-GDP ratios were as high as those of countries in crisis, but guaranteed by the 'virtual' reserves of their national central banks. Finally, a third generation of target zone modeling is represented by its application to the current crisis of economic globalization and has been extended to merge it with heterogeneous agents modeling. [ABSTRACT FROM AUTHOR]

The aim of this paper is twofold. Firstly, we present a model in which both income and income inequality are jointly determined in a counter-cyclical manner via self-fulfilling expectation. We argue that multiple equilibria can arise in the presence of inelastic labor demand, a minimum investment requirement, and imperfections in the credit market. In one equilibrium, the market wage and labor income are both low. Young agents who become entrepreneurs work harder and save more than young agents who become depositors. As a result, the equilibrium is characterized by low-income and high-income inequality. In another equilibrium, the market wage and labor income are both high. Young agents supply the same amount of labor and save the same. As a result, the equilibrium is characterized by high-income and low-income inequality. Secondly, we present different dynamic scenarios predicted by the model and analyze the role of self-fulfilling expectations. The paper ends by providing some policy recommendations on how the coordination of agents' expectations about labor market conditions and how improvements in financial development may affect the long-run income and income inequality. [ABSTRACT FROM AUTHOR]

This paper adopts a target zone approach to analyse and interpret the current phase of slowdown, if not retreat, of economic globalisation. A 'honeymoon' emerges when a credible limit is imposed on its economic and social costs. Conversely, if the upper cost threshold is not set credibly, a 'divorce' from economic globalisation emerges earlier than if no target is taken into account. Such a second case represents the recent events. [ABSTRACT FROM AUTHOR]

This paper analyzes the current phase of backlash of economic globalization using a target zone approach in an environment populated by heterogeneous agents. The target zone analysis suggests that there may be a positive expectation effect (a 'honeymoon') when the social costs are credibly expected to remain below the benefits arising from globalization. In such a situation, the latter proceeds even beyond the level that society would be willing to accept in the absence of a such a target. When the costs are expected to exceed the benefits, instead, the opposite phenomenon (a 'divorce') arises. While in the case of exchange rates or interest rates, the passage from 'honeymoon' to 'divorce' might well occur with a discrete jump of the respective variable, rather than gradually, this is not the case when considering economic and social costs. Graduality is obtained thanks to the introduction of the hypothesis of heterogeneous agents. The proportion of those who think that the costs of globalization exceed the benefits increases with globalization and the 'honeymoon", then, gradually turns into a 'divorce'. Government's redistributive intervention to compensate the losers, however, could reduce the costs of globalization, thereby delaying or even preventing its crisis. [ABSTRACT FROM AUTHOR]

This paper examines the dynamic effects of consumption externalities in Bosi and Seegmuller (J Math Econ 46:475–492, 2010). We show that only the patient agent holds the entire capital stock at the steady state, while the impatient agent works to finance his consumption. Our main result states that consumption externalities represent the main mechanism that explains the emergence of endogenous fluctuations due to self-fulfilling expectations. Finally, consumption externalities promote the appearance of deterministic cycles of period two. [ABSTRACT FROM AUTHOR]

This article nests the explanations of the euro crisis in terms of economic, political and institutional causes within the diverging fundamentals vs. self-fulfilling expectations debate. It argues that explanations based on fundamental divergences refer to a subset of economic variables only, while those based on self-fulfilling expectations refer to political and institutional variables. However, since there is no reason not to include the latter among the fundamental variables of an economy, there is no need to refer to negative self-fulfilling expectations as an explanation for the crisis. In the paper, the role played by political and institutional variables, namely federal and monetary solidarity, is formalized in a simple model of diverging fundamentals that goes beyond the consideration of economic variables only. JEL Classification: E58, E65, F36, F45, G01

In a closed economy setting a cash-in-advance monetary economy under money growth targeting is prone to self-fulfilling expectations and beliefs-driven fluctuations. This paper shows that such extrinsic instability is less of a problem in a small open economy integrated in the world goods and financial markets. This is because endogenous terms-of-trade movements associated with global goods trade and cross-border capital flows and endogenous international asset price adjustments associated with global financial transaction serve as an endogenous stabilizer to reduce the likelihood of sunspot equilibria. We find that for empirically reasonable parametrization of the small open economy sunspot beliefs are unlikely to become self-fulfilled. [ABSTRACT FROM AUTHOR]

It has long been demonstrated that in a closed economy a balanced‐budget fiscal policy can induce aggregate instability unrelated to economic fundamentals. The empirical relevance of this result has been challenged by many studies. In this paper, we show that such extrinsic instability associated with a balanced‐budget rule is a robust phenomenon in a similar closed‐economy setting enhanced with endogenous capital utilization. This suggests that the design or operation of a balanced‐budget fiscal policy should recognize that it may constitute a potential source of self‐fulfilling prophecies and belief‐driven fluctuations. [ABSTRACT FROM AUTHOR]

The paper shows that currencies of countries with persistent current account surpluses and high foreign-currency denominated assets, such as the Swiss franc and the Japanese yen, are under persistent appreciation pressure, particularly when the centres of the world monetary system follow expansionary monetary policies. This limits the choice of exchange rate regime. Given flexible exchange rates, a negative risk premium on the domestic interest rate can emerge. Empirical estimations provide mixed evidence for a negative impact of net foreign asset positions and exchange rate uncertainty on interest rates of international creditor countries at the periphery of the world monetary system. [ABSTRACT FROM AUTHOR]

We investigate the relationship of the market pricing of sovereign risk to default, through credit default swap (CDS) spreads for 16 Eurozone countries during 2008q1–2013q3. We take into account, through appropriate non-linear generalized method of moments (GMM) estimations the endogeneity problem. We focus on ‘fiscal space’ (DEBTorFISCAL), and the downgrade announcements (DOWN). We findDEBT(FISCAL) to have significant (insignificant) effects on theCDSconcave function, as well as,DOWNin a linear one. It has also been confirmed significant pricing discrimination between South and West Euro Area Periphery (SWEAP) and the core Eurozone, highlighting asymmetries discovered either by the respective size of estimatedDEBTcoefficients or by the significant effects ofDOWNthat have only onCDSof SWEAP countries. The current account balance or the inflation rate, as well as, relevant interaction terms seem not to affect the spreads of the EMU. These findings, together with the estimated structural change onCDSpattern in early 2011, coinciding with significant either theDOWNin the pre-crisis period (2008–2010) or theDEBTin the post-crisis one (2011–2013) on theCDS, seem to be consistent with self-fulfilling crises literature and the inherent vulnerability of EMU, on other words, the ‘fragility hypothesis of the Eurozone’. [ABSTRACT FROM PUBLISHER]

This paper shows how the debt-overhang distortion on bank lending can generate a self-fulfilling-expectations banking crisis accompanied by a plunge in the value of banks’ assets and a contraction of bank lending and economic activity. Moral hazard in banking adds an additional channel that can generate multiple equilibria, worsen the debt-overhang distortion, and deepen the crisis. Some signals of systemic risk include: high volatility and the presence of two modes in the probability distribution functions of the returns on bank-issued bonds and on portfolios of bank-issued bonds and equities; and high correlation between the returns on bank-issued bonds. Macroprudential regulation should discourage the exposure of banks to the economic and financial cycle by raising the capital requirements for banks with more cyclical assets. [ABSTRACT FROM AUTHOR]

The recent euro area crisis shows some similarities with the fixed exchange rate crisis that affected the European Monetary System in 1992-93. I argue that the theoretical framework to be used in order to analyze them should also be similar. As a matter of fact, in both cases, the point of view of the government (that compares costs and benefits of its action) should be considered together with the point of view of speculators, who look at the state of the economic fundamentals in order to decide whether to launch an attack or not. This allows to represent and to interpret, among other things, both the initial 'honeymoon' years of EMU and the recent euro area crisis. [ABSTRACT FROM AUTHOR]

This paper explores the determinants of 10-year sovereign bond spreads over the German Bund benchmark in the Euro Zone from 2000 to 2013, relying on cross-country quarterly data panel analysis. The paper focal point is the role of contagion and euro break-up risks in widening the sovereign bond yield differentials among EU member countries. Using a novel synthetic index capable of monitoring the sustainability of currency unions, the paper finds that market expectations of a euro’s break up and contagion from Greece were fundamental drivers of sovereign risk premia in peripheral countries. [ABSTRACT FROM PUBLISHER]

Increasing returns to scale and firms' market power are two potential sources of sunspot expectations in neoclassical models. We show that in New Keynesian models, returns to scale and market power can have fundamentally different implications for broad macroeconomic issues, including self-fulfilling expectations, depending on the nature of price rigidity. Our findings suggest that the design of stabilization monetary policy can depend on precise knowledge about the economy's real and nominal features. Therefore, a clear understanding of the specific economic environment and its relevance to monetary policymaking for ensuring macroeconomic stability can be an integrated part of monetary policy practice. [ABSTRACT FROM AUTHOR]

Countries with higher implicit taxes on continued work are associated with lower labor force participation rates of the elderly. This paper constructs a politico-economic model that accounts for this feature based on multiple, self-fulfilling expectations of agents. In this model, agents are identical at birth and can become skilled (or remain unskilled) through educational investment. When agents hold expectations of larger social security benefits, it provides a disincentive to engage in educational investment, thereby resulting in an unskilled majority. In turn, this unskilled majority supports larger social security benefits, which induces the retirement of the elderly and thus results in a lower labor force participation rate. The opposite applies when agents have expectations of smaller social security benefits in their old age. [ABSTRACT FROM AUTHOR]

Financial crises are often associated with an endogenous credit reversal followed by a fall in asset prices and serious disruptions in the financial sector. To account for this sequence of events, this paper constructs a model where excessive risk-taking by investors leads to a bubble in asset prices, and where the supply of credit to these investors is endogenous. We show that the interplay between excessive risk-taking and the endogeneity of credit may give rise to multiple equilibria associated with different levels of lending, asset prices, and output. Stochastic equilibria lead, with positive probability, to an inefficient liquidity dry-up, a market crash, and widespread failures by borrowers. The possibility of multiple equilibria and self-fulfilling crises is shown to be related to the severity of the risk-shifting problem in the economy. [ABSTRACT FROM AUTHOR]

We show that dependence on foreign energy can increase economic instability by raising the likelihood of equilibrium indeterminacy, hence making it easier for fluctuations driven by self-fulfilling expectations to occur. This is demonstrated in a standard neoclassical growth model. Calibration exercises, based on the estimated share of imported energy in production for several countries, show that the degree of reliance on foreign energy for many countries can easily make an otherwise determinate and stable economy indeterminate and unstable. [ABSTRACT FROM AUTHOR]

This article highlights the spread of bank panics across countries, as the public reassesses governments' propensity to bailouts. Policymakers decide whether to save collapsing banking systems by weighing social costs of crises against the costs associated with raising taxes to finance rescue packages. Policymakers know those social costs of bank liquidation whereas the public does not. In this setup, financial crises may result from the public's self-fulfilling prophecies about equilibrium outcomes, as lenders' expectations impinge on the taxation cost of bailouts. It follows that a banking crisis in a country leads creditors to reexamine policymakers' willingness to bailouts in other countries, which eventually makes their banks more vulnerable to self-confirming depositors' runs. [ABSTRACT FROM AUTHOR]

An extensive literature discusses the existence of a virtuous circle of expectations that might lead communities to Pareto-superior states among multiple potential equilibria. It is generally accepted that such multiplicity stems fundamentally from the presence of positive agglomeration externalities. We examine a two-sector model in this class and look for intertemporal perfect foresight equilibria. It turns out that under some plausible conditions, positive externalities must coexist with external diseconomies elsewhere in the model, for there to exist equilibria that break free of historical initial conditions. Our main distinguishing assumption is that the positive agglomeration externalities appear with a time lag (that can be made vanishingly small). Then, in the absence of external diseconomies elsewhere, the long-run behaviour of the economy resembles that predicted by myopic adjustment. This finding is independent of the degree of forward-looking behavior exhibited by the agents. [ABSTRACT FROM AUTHOR]