Debt Persistence in a Deflationary Environment: A Regime-Switching Model

Debt dynamics have been a central theme of discussioins in the "Great Recession". The aim of the present paper is to study the persistence of sovereign debt within a business cycle perspective. In order to achieve this result, a Keynesian framework is considered where aggregate demand fluctuations generate quantity adjustment within a deflationary environment. Furthermore a regime switching technique, capable of generating bounded and robust endogenous fluctuations, is introduced. The piecewise linearity of the model, along with its discontinuities, obliges to operate with a low dimensional system in order to obtain two analytical results: the robustness of bounded fluctuations, and hence of debt persistence, and the driving role of growth. These results are extended to higher dimensions by means of simulations. Also in this case, the effectiveness of policies is confirmed.