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Sovereign Risk and Macroeconomic Fluctuations in an Emerging Market Economy

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Author Info

  • Markus Kirchner

    ()
    (University of Amsterdam)

  • Malte Rieth

    ()
    (University of Dortmund)

Abstract

This paper assesses the role of sovereign risk in explaining macroeconomic fluctuations in Turkey. We estimate two versions of a simple New Keynesian small open economy model on quarterly data for the period 1994Q3-2008Q2: A basic version and a version augmented by a default premium on government debt due to a perceived risk of sovereign debt default. Model comparisons clearly support the augmented version since it leads to stronger internal propagation and hence smaller shocks are required in order to reconcile the observed dynamics of nominal and real variables, leading to better forecasting performance. The estimated default probability is highly debt-elastic, indicating that default fears are a relevant concern. The results suggest that the augmented model may lead to a better understanding of macroeconomic fluctuations in emerging market economies that are subject to sovereign risk. In terms of policy implications, counterfactual experiments show that both more active monetary policy and stronger fiscal feedbacks from debt on taxes can lead to less volatile inflation and debt dynamics, but higher debt feedbacks on taxation additionally reduce expected default rates.

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 10-100/2.

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Date of creation: 10 Nov 2010
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Handle: RePEc:dgr:uvatin:20100100

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Web page: http://www.tinbergen.nl

Related research

Keywords: Sovereign default risk; Macroeconomic fluctuations; Emerging market economies; Small open economy models; Monetary and fiscal policy;

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Cited by:
  1. Villa, Stefania, 2013. "Financial frictions in the euro area: a Bayesian assessment," Working Paper Series 1521, European Central Bank.

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