To this end, we draw on regression results reported in Gärtner, Griesbach and Jung (2011)1. These provide both estimates of the effect of interest rates and other macroeconomic variables on a country's sovereign debt rating, and also estimates of how sovereign debt ratings bear on interest rates. Equilibria in such interactive systems may be inherently stable or unstable, unique or not. In a first step, we identify confidence bands around regression lines and proceed to explore the equilibria and dynamic properties implied and permitted by these results. In a second step, we exploit the fact that some estimates point to a nonlinear effect of country ratings on interest rates and look at whether this nonlinearity is strong enough to support the notion of multiple equilibria under a reasonable set of assumptions.
Two key results emerge from this research: First, there is a good equilibrium which is stable and in which ratings are excellent and interest rates are low. Second, there is a strong possibility of a second equilibrium which is inherently unstable and thus defines a threshold. Once this threshold is broken, an accelerating spiral of rating downgrades and interest rate increases is set in motion which may only be stopped by exogenous policy intervention. The likelihood of this to occur and the exact position of this threshold depend on how strongly interest rate increases affect other determinants of sovereign debt ratings, which include deficit ratios and income growth.
1 Gärtner, M., B. Griesbach and F. Jung (2011). PIGS or Lambs? The European Sovereign Debt Crisis And the Role of Rating Agencies. International Advances in Economic Research 17(3): 288-299.