Signalling Debt Sustainability
AbstractThis paper studies the optimal debt repayment policy of a government facing a credibility problem: the public is uncertain about whether the outstanding public debt will be repaid in full or in part and requires a risk premium to roll it over. The model determines when it is optimal for the government in power to signal the sustainability (full repayment) or the non-sustainability (partial repayment) of the debt regime. The timing depends on the initial reputation of the government, the costs of taxing labour income, and the costs of defaulting on government debt, which are endogenized as a function of the redistributive preferences of the government. In the presence of a deficit net of interest payments, the uncertainty may or may not be resolved, but it will always be resolved when a lasting surplus net of interest payments is achieved. The model allows an evaluation of the deficit and the debt prerequisites for EMU set by the Maastricht Treaty: they are sufficient to exclude potentially defaulting governments, but may be excessively strict for this purpose.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 787.
Date of creation: May 1993
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Find related papers by JEL classification:
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
- E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
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- Heinemann, Friedrich, 1998. "The EMU Consolidation Game - or: Does 3.0 Really Mean 3.0?," ZEW Discussion Papers 98-01, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
- Drudi, Francesco & Prati, Alessandro, 2000.
"Signaling fiscal regime sustainability,"
European Economic Review,
Elsevier, vol. 44(10), pages 1897-1930, December.
- Francesco Drudi & Alessandro Prati, 1998. "Signaling Fiscal Regime Sustainability," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 335, Bank of Italy, Economic Research and International Relations Area.
- Drudi, F. & Prati, A., 1998. "Signaling Fiscal Regime Sustainability," Papers, Banca Italia - Servizio di Studi 335, Banca Italia - Servizio di Studi.
- Alessandro Prati & Francesco Drudi, 1999. "Signaling Fiscal Regime Sustainability," IMF Working Papers 99/86, International Monetary Fund.
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