Annex: Chapter 7

Manmohan Singh

We present a simple extension of the model in Geanakoplos and Wang (2017).¹¹ Readers can refer to Geanakoplos and Wang (2017) for more details about the model setup. The model is abstract and may not be applicable to all practical policy choices. Consider a simple endowment economy with two countries: an AE and an EM. Time is discrete, and there are two periods: t = 0, 1. There are two possible states in period 1: U, D, where U stands for the “Up” state and D for the “Down” state. Agents in both economies consume a single consumption good C. Each economy has two kinds of government bonds. The first is a riskless bond that is analogous to short-term government bonds, such as Treasury bills. The riskless bond pays one unit of money in both U and D, and their payoffs (promises) will be paid by the issuing government from tax revenues. For simplicity, we assume that there is a fixed exchange rate (equal to one) between the AE and the EM. Denote the riskless bond as B.

The second type of government bond is a risky real bond and is analogous to long-term government bonds, whose payoff (eg, par value) can vary across different states in the second period.²² We do not seek to model the