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Data on the credit rating of bonds issued in the first half of the 1990s suggest that investors in emerging market securities paid little attention to credit risk, or that they were comfortable with the high level of credit risk that they were incurring. This chapter develops a paradigm for intertemporal optimization under uncertainty in a finite horizon discrete time context, with the constraint that there be no default on short-term foreign currency denominated debt. The object is to select consumption, investment, and the resulting short-term debt in the first period to maximize the expected present value of the utility of consumption over both periods. The constraint is that regardless of the state of nature in the second period, there will be no default on the debt.

This chapter addresses the sustainability of debt. A systematic analysis based on the International Monetary Fund's (IMF) methodology to evaluate fiscal sustainability shows that Castile was able to service its debts in the long run. While liquidity was scarce during periods of intense warfare, years of relative peace brought large surpluses. The data collected from Castile's annual fiscal accounts produced new yearly series of revenue, military expenditure, short-term debt issues, and short-term debt service. The resulting database spans a full 31-year period—enough to employ modern quantitative techniques. This analysis provides strong evidence that Castile's fiscal position in the second half of the sixteenth century was on a solid footing. The chapter then assesses whether the events that led to major downturns in Castile's financial fortunes could have been anticipated.

In this chapter, we analyze alternative sources of short‐term financing, as well as useful criteria for managing them. We start by considering criteria for selecting optimal debt maturity structures. Next, we present alternative sources of short‐term debt, such as bank financing, factoring, asset‐backed securities, letters of credit, commercial paper, and bankers' acceptances. We continue by describing the typical covenants established around debt contracts. Finally, we discuss the optimal number of creditors and the objectives that a firm should consider in order to make this particular choice.

The Extraordinaire des Guerres military treasury raised short-term loans in the mid-1690s on a limited scale, and keeping this within bounds allowed the treasurers a margin of credit for military emergencies. But in the 1700s they were forced into colossal flotations because of general revenue shortages, appropriations failings, and generally inefficient channelling of loans elsewhere in the fiscal system. Chamillart wilfully used the Extraordinaire as a part of the credit-raising machinery, and the loans were increasingly extended, sometimes for years. After 1708 interest, held down at artificially low rates, was paid erratically, and there was a wider failure to allocate funds for repayment of capital, damaging confidence and discouraging further lending. Speculation became rampant and the trading values of Extraordinaire bearer bills plummeted. Moreover, the arbitrary and thoroughly incomplete manner in which the bills were withdrawn after 1710 almost destroyed credit at a time when the Allies invaded France.

Bagehot's Rule for fighting crises has never been updated because there have been few crises in developed economies. Examining historical experiences suggests some principles for fighting crises. One principle is to find the short-term debt. Another is to manage the information environment. Open emergency lending facilities. Do not let large banks fail during a crisis. These rules, and others, provide a more complete guide to fighting crises, an update of Bagehot's Rule.

It has been suggested that the government should increase the effective supply of public short-term debt in order to meet the demand by institutional cash managers for safe short-term debt. If the government eliminated private issuance of short-term debt by issuing enough public short-term debt to satisfy this demand, then there could be no runs and no contagion. The same result could be achieved if the remaining short-term debt of the financial system was so small that runs would not be significant. These policies can be characterized as “crowding out” private short-term debt. This chapter discusses crowding out by the Treasury and the Federal Reserve. The Treasury could crowd out runnable private short-term debt by replacing a certain amount of long-term Treasury debt issuance with shorter term Treasury debt. Investors that would otherwise buy and hold private short-term debt would instead buy Treasuries. The Federal Reserve could “crowd out” private short-term debt, using its new tools of monetary policy—interest on excess reserves (IOER) and reverse repurchase agreements (RRPs).

This chapter centers on the paradox of poverty in the midst of affluence, and how despite twenty years of relatively low interest rates after World War II, racial inequality deepened between cities and suburbs, and within cities, too. Although President Lyndon B. Johnson encouraged cities to pair their financial powers with that of the federal government to tackle such inequities, these ambitions were soon dashed. This chapter considers the “credit crunch” of the late 1960s in relation to cities, underscoring how the end of the era of low interest rates benefited creditors and made it immensely difficult for cities to borrow.

Investment in fixed assets declined over the crisis period in all countries. We implement an econometric analysis to explore the differential impact of leverage and debt maturity structure on investment, finding that in crisis years (i) leverage exerts a strong and negative effect on investment, and (ii) firms with more long-term debt invest less. We uncover heterogeneous reactions to the crisis due to the level of debt and its maturity, sorting firms by country-specific and firm-specific characteristics. Firms which cut back most investment in crisis years (conditional on the level of leverage and maturity) are (i) small and (ii) located in Eurozone periphery countries. Factors that alleviate financial friction and shield investment include multiple bank relationships and the ability to generate internal resources (cash flow). We find no evidence of a positive nexus between cash and investment, and little evidence of a positive effect on investment of access to capital markets.

This chapter examines how the Treasury reduced wartime debt. Andrew Mellon, Secretary of the Treasury, and his colleagues first addressed the problem of refinancing the postwar overhang of short-term debt and then put in place the program of regular tax date financings that became the backbone of Treasury debt operations in the 1920s. Between mid-1923 and early 1927, they whittled down the Third Liberty bonds as sinking fund appropriations became available, but when tax receipts exploded in early 1927, they had the mental agility to make a midcourse correction, switching their attention to the Second Liberty bonds and calling those bonds for early redemption. They also made use of intermediate-term securities in the second half of the decade, three times offering 5-year notes callable in three years.

This chapter argues that panics—widespread redemptions of short-term debt—should be viewed as the central problem for financial stability policy. This is not a novel argument, but it is a surprisingly controversial one. It is common today to see panics as mere symptoms or manifestations of other, purportedly more “fundamental” problems: “debt-fueled bubbles,” “overleverage,” “excessive risk-taking,” and so on. The chapter makes the case that these other phenomena are unlikely to pose a grave threat to the broader economy in the absence of a panic. The chapter adduces evidence from the recent financial crisis and the Great Recession, and from previous historical episodes, in support of this position. The chapter focuses on a particular mechanism through which panics damage the broader economy—the “panic-induced financing crunch”—and it suggests that financial market anomalies during the recent crisis provide dramatic evidence that this mechanism was at work. The chapter concludes that panic-proofing, as opposed to, say, debt-fueled bubble prevention or “systemic risk” mitigation, should be the main objective of financial stability policy.

This chapter argues that panics—widespread redemptions of short-term debt—should be viewed as the central problem for financial stability policy. This is not a novel argument, but it is a surprisingly controversial one. It is common today to see panics as mere symptoms or manifestations of other, purportedly more “fundamental” problems: “debt-fueled bubbles,” “overleverage,” “excessive risk-taking,” and so on. The chapter makes the case that these other phenomena are unlikely to pose a grave threat to the broader economy in the absence of a panic. The chapter adduces evidence from the recent financial crisis and the Great Recession, and from previous historical episodes, in support of this position. The chapter focuses on a particular mechanism through which panics damage the broader economy—the “panic-induced financing crunch”—and it suggests that financial market anomalies during the recent crisis provide dramatic evidence that this mechanism was at work. The chapter concludes that panic-proofing, as opposed to, say, debt-fueled bubble prevention or “systemic risk” mitigation, should be the main objective of financial stability policy.

Financial crises are runs on short-term debt. These crises occur in all market economies, though a country may go for a long period before experiencing one. Understanding how to fight financial crises is very important because, as the financial system changes through time, new forms of short-term debt arise that are vulnerable to runs. The time-honored rule for fighting crises is Bagehot’s rule, articulated in 1873. But, we have learned much more than this rule through history. Studying the history of how private bank clearing houses fought crises results shows that that the experience of fighting crises involves much more than Bagehot’s rule.

Declining tax revenues forced the French monarchy deeper and deeper into debt in the War of the Spanish Succession. As the 1690s and 1700s wore on the direct tax agents and the farmers general floated more and more short-term loans, using their own credit and the revenues they collected as pledges, but the interest rates charged were relatively high. It was not until 1710 that the receivers general for direct taxes were organised into a more solid consortium for better managing credit flows. Through the Paris city hall and other corporate bodies the government also floated vast numbers of long-term rentes, fairly illiquid annuity bonds, to cover the bulk of the debt. Most costly of all, though, were the contracts the king entered into with rapacious financiers to raise money through venal offices: these were largely in the form of new positions and forced loans on existing officials.

This chapter reviews recent evidence on the use of long-term finance in developing countries (relative to developed ones) to try to identify where short- and long-term financing occurs, and what role different financial intermediaries and markets play in extending this type of financing. Although banks are the most important providers of credit, they do not seem to offer long-term financing. In fact, loans in developing countries have significantly shorter maturities than those in developed countries. Capital markets have become increasingly sizable since the 1990s and can provide financing at fairly long terms. But just a few large firms use these markets. Only some institutional investors provide funding at long-term maturities. Incentives for asset managers are tilted toward the short term due to constant monitoring. Instead, asset-liability managers have a longer-term horizon, as foreign investors in developing countries do. Governments might help expand long-term financing, although with limited policy tools.

This chapter presents a literature survey of the economic theories underlying fiscal policy and public debt and its impact on national income and growth. The coverage is particularly focused on the standard theories of the mainstream literature that considers short-run and long-run impact of government deficit and debt. While in the short run increased government expenditure or tax cut would lead to increase in aggregate demand that would raise national income, long-term impact of public debt could entirely be different. The equivalence of debt-financed and tax-financed public expenditure (Barro-Ricardo propositions) is also looked into and the chapter notes its limited relevance in view of its restrictive assumptions. Some insights from the non-mainstream literature, which in general, are more favourably disposed towards fiscal activism, are also covered. Finally, the chapter takes up the recent empirical literature and related controversies following Reinhart and Rogoff’s finding of 90 per cent threshold debt-GDP ratio.