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Revisiting the fiscal theory of sovereign risk from a DSGE viewpoint

Author

Listed:
  • Okano Eiji

    (Nagoya City University)

  • Kazuyuki Inagaki

    (Nanzan University)

Abstract

We revisit Uribe's[32]'fiscal theory of sovereign risk,' which suggests a trade-off between stabilizing inflation and suppressing default. Unlike Uribe[32], we develop a class of dynamic stochastic general equilibrium models in which the fiscal surplus is endogenous, but where the default mechanism follows Uribe[32] with nominal rigidities. We find that an optimal monetary and fiscal policy, in which both the nominal interest rate and the tax rate are policy instruments, not only stabilizes inflation and the output gap, but also default through stabilizing the fiscal surplus. Thus, there is not necessarily a trade-off between stabilizing inflation and suppressing default.

Suggested Citation

  • Okano Eiji & Kazuyuki Inagaki, 2019. "Revisiting the fiscal theory of sovereign risk from a DSGE viewpoint," BCAM Working Papers 1901, Birkbeck Centre for Applied Macroeconomics.
    • Handle: RePEc:bbk:bbkcam:1901
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    File URL: https://eprints.bbk.ac.uk/28256/1/28256.pdf
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    Cited by:

    1. Eiji Okano & Masataka Eguchi, 2020. "The importance of default risk awareness in conducting monetary and fiscal policies," Eurasian Economic Review, Springer;Eurasia Business and Economics Society, vol. 10(3), pages 361-392, September.

    More about this item

    Keywords

    Sovereign Risk; Optimal Monetary Policy; Fiscal Theory of the Price Level;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General

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