Ekrame Boubtane

Useful to summarize the discussion about debt and spreads in a graph (based on work with @pmbruera and @Gonhuertas. Working paper out soon). The blue line shows the “good equilibrium” if investors are rationally optimistic. At very low debt, no risk of default, no spread, then a slow increase, and eventually a sudden jump and default. So, if things get worse (high continuing deficits, increasing debt ratio), reasons to worry. But, even if things do not get worse, and investors turn (rationally) pessimistic, they require a larger spread, the interest rate jumps and default happens faster. I think France is roughly at point A: small spread, but reasons to worry. Deficit is too large, so France keeps moving to the right. And, even if not, equilibrium could jump to point B, with a higher spread.