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Fiscal Stimulus under Sovereign Risk

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  • Javier Bianchi
  • Pablo Ottonello
  • Ignacio Presno

Abstract

What is the optimal fiscal policy response to a recession when the government is subject to sovereign risk? We study this question in a model of endogenous sovereign default with nominal rigidities. Increasing spending in a recession reduces unemployment, but it exposes the government to a debt crisis. We quantitatively analyze this trade-off between stimulus and austerity and find that expanding government spending may be undesirable, even in the presence of sizable Keynesian stabilization gains and inequality concerns. Consistent with these findings, we show that sovereign risk is a key driver of the fiscal procyclicality observed worldwide.

Suggested Citation

  • Javier Bianchi & Pablo Ottonello & Ignacio Presno, 2023. "Fiscal Stimulus under Sovereign Risk," Journal of Political Economy, University of Chicago Press, vol. 131(9), pages 2328-2369.
    • Handle: RePEc:ucp:jpolec:doi:10.1086/724317
    DOI: 10.1086/724317
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    More about this item

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General

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