We study an impatient, risk-neutral government that cannot commit to a particular debt path, financed by competitive lenders. In equilibrium, debt adjusts slowly toward a debt-to-income target, exacerbating booms and busts. Strikingly, gains from trade dissipate when trading is continuous, leaving the government no better off than in financial autarky, owing to a sovereign “debt ratchet effect.” Moreover, citizens who are more patient than their government are strictly harmed. We characterize equilibrium debt dynamics, ergodics, and comparative statics when income follows a geometric Brownian motion and analyze devices that allow the sovereign to recapture gains from trade.

How much ability does the Fed have to stimulate the economy by cutting interest rates? We argue that the presence of substantial debt in fixed-rate, prepayable mortgages means that the ability to stimulate the economy by cutting interest rates depends not just on their current level but also on their previous path. Using a household model of mortgage prepayment matched to detailed loan-level evidence on the relationship between prepayment and rate incentives, we argue that recent interest rate paths will generate substantial headwinds for future monetary stimuli. (JEL E32, E43, E52, E58, G21, G51)