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Sovereign risk and belief-driven fluctuations in the euro area

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  • Corsetti, Giancarlo
  • Kuester, Keith
  • Meier, André
  • Müller, Gernot

Abstract

Sovereign risk premia in several euro area countries have risen markedly since 2008, driving up credit spreads in the private sector as well. We propose a New Keynesian model of a two-region monetary union that accounts for this "sovereign risk channel." The model is calibrated to the euro area as of mid-2012. We show that a combination of sovereign risk in one region and strongly procyclical fiscal policy at the aggregate level exacerbates the risk of belief-driven deflationary downturns. The model provides an argument in favor of coordinated, asymmetric fiscal stances as a way to prevent self-fulfilling debt crises.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9723.

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Date of creation: Nov 2013
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Handle: RePEc:cpr:ceprdp:9723

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Keywords: euro area; monetary union; pooling of sovereign risk; risk premium; sovereign risk channel; zero lower bound;

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References

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  1. Philip R. Lane, 2012. "The European Sovereign Debt Crisis," Journal of Economic Perspectives, American Economic Association, vol. 26(3), pages 49-68, Summer.
  2. Ugo Panizza & Federico Sturzenegger & Jeromin Zettelmeyer, 2009. "The Economics and Law of Sovereign Debt and Default," Journal of Economic Literature, American Economic Association, vol. 47(3), pages 651-98, September.
  3. Robert Kollmann & Werner Roeger & Jan in't Veld, 2012. "Fiscal Policy in a Financial Crisis: Standard Policy versus Bank Rescue Measures," American Economic Review, American Economic Association, vol. 102(3), pages 77-81, May.
  4. Michael Woodford, 2010. "Simple Analytics of the Government Expenditure Multiplier," Discussion Papers 0910-09, Columbia University, Department of Economics.
  5. Eduardo A. Cavallo & Patricio Valenzuela, 2010. "The determinants of corporate risk in emerging markets: an option-adjusted spread analysis," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 15(1), pages 59-74.
  6. Ugo Panizza & Eduardo Levy Yeyati, 2006. "The Elusive Costs of Sovereign Defaults," IDB Publications 6713, Inter-American Development Bank.
  7. Bi, Huixin, 2012. "Sovereign default risk premia, fiscal limits, and fiscal policy," European Economic Review, Elsevier, vol. 56(3), pages 389-410.
  8. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, vol. 98(3), pages 690-712, June.
  9. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-61, September.
  10. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Closing Small Open Economy Models," Departmental Working Papers 200115, Rutgers University, Department of Economics.
  11. Robert Kollmann & Marco Ratto & Werner Roeger & Jan in't Veld, 2012. "Fiscal Policy, Banks and the Financial Crisis," European Economy - Economic Papers 464, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
  12. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  13. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-Fulfilling Debt Crises," Levine's Working Paper Archive 114, David K. Levine.
  14. Nathalie Girouard & Christophe André, 2005. "Measuring Cyclically-adjusted Budget Balances for OECD Countries," OECD Economics Department Working Papers 434, OECD Publishing.
  15. Corsetti, Giancarlo & Kuester, Keith & Meier, André & Müller, Gernot, 2012. "Sovereign Risk, Fiscal Policy, and Macroeconomic Stability," CEPR Discussion Papers 8779, C.E.P.R. Discussion Papers.
  16. Robert E. Hall, 2009. "By How Much Does GDP Rise If the Government Buys More Output?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 40(2 (Fall)), pages 183-249.
  17. Corsetti, Giancarlo & Dedola, Luca, 2013. "The Mystery of the Printing Press: Self-fulfilling debt crises and monetary sovereignty," CEPR Discussion Papers 9358, C.E.P.R. Discussion Papers.
  18. Vasco Cúrdia & Michael Woodford, 2009. "Credit frictions and optimal monetary policy," BIS Working Papers 278, Bank for International Settlements.
  19. Serkan Arslanalp & Yin Liao, 2013. "Contingent Liabilities and Sovereign Risk: Evidence from Banking Sectors," CAMA Working Papers 2013-43, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  20. Edda Zoli, 2013. "Italian Sovereign Spreads," IMF Working Papers 13/84, International Monetary Fund.
  21. Ugo Albertazzi & Tiziano Ropele & Gabriele Sene & Federico M. Signoretti, 2012. "The impact of the sovereign debt crisis on the activity of Italian banks," Questioni di Economia e Finanza (Occasional Papers) 133, Bank of Italy, Economic Research and International Relations Area.
  22. Stefano Neri, 2013. "The impact of the sovereign debt crisis on bank lending rates in the euro area," Questioni di Economia e Finanza (Occasional Papers) 170, Bank of Italy, Economic Research and International Relations Area.
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Cited by:
  1. Christophe Blot & Marion Cochard & Jérôme Creel & Bruno Ducoudre & Danielle Schweisguth & Xavier Timbeau, 2014. "Fiscal consolidation in times of crisis: is the sooner really the better?," Sciences Po publications info:hdl:2441/2g7mhju69b9, Sciences Po.
  2. repec:spo:wpecon:info:hdl:2441/2g7mhju69b94obeaqlen09s1au is not listed on IDEAS

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