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Sovereign Risk, Fiscal Policy, and Macroeconomic Stability

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Author Info

  • Keith Kuester
  • Gernot J. Mueller
  • Giancarlo Corsetti
  • André Meier

Abstract

This paper analyzes the impact of strained government finances on macroeconomic stability and the transmission of fiscal policy. Using a variant of the model by Curdia and Woodford (2009), we study a "sovereign risk channel" through which sovereign default risk raises funding costs in the private sector. If monetary policy is constrained, the sovereign risk channel exacerbates indeterminacy problems: private-sector beliefs of a weakening economy may become self-fulfilling. In addition, sovereign risk amplifies the effects of negative cyclical shocks. Under those conditions, fiscal retrenchment can help curtail the risk of macroeconomic instability and, in extreme cases, even stimulate economic activity.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 12/33.

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Length: 56
Date of creation: 01 Jan 2012
Date of revision:
Handle: RePEc:imf:imfwpa:12/33

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Keywords: Risk premium; Sovereign debt; monetary policy; government spending; spending cuts; central bank; inflation; fiscal policy; fiscal retrenchment; public debt; taxation; tax revenue; monetary fund; aggregate demand; public spending; public finances; primary deficit; fiscal adjustment; tax rates; fiscal tightening; tax burden; fiscal deficit; fiscal contractions; fiscal multiplier; fiscal outlook; fiscal stance; fiscal deficits; debt obligations; fiscal situation; fiscal multipliers; budget deficit; fiscal restraint; fiscal institutions; fiscal austerity; fiscal consolidation; government expenditure; optimal monetary policy; debt service; fiscal years; discretionary fiscal policy; tax system; expansionary fiscal contractions; tax policy; public debt reverse; long-term interest rates; fiscal variables; fiscal crisis; budget constraint; public deficits; fiscal behavior; tax revenues; government deficit; expansionary fiscal; fiscal stabilization; fiscal variable; budget deficits; fiscal position; budget balances; monetary policy operations; future fiscal deficits; monetary economics; monetary response; monetary regime; fiscal discipline; fiscal response; fiscal expansions; level of indebtedness;

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References

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  1. Eduardo A. Cavallo & Patricio Valenzuela, 2007. "The Determinants of Corporate Risk in Emerging Markets," IMF Working Papers 07/228, International Monetary Fund.
  2. Troy Davig & Eric M. Leeper, 2006. "Generalizing the Taylor Principle," Caepr Working Papers 2006-001, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
  3. Silvia Ardagna & Francesco Caselli & Timothy Lane, 2004. "Fiscal Discipline and the Cost of Public Debt Service: Some Estimates for OECD Countries," NBER Working Papers 10788, National Bureau of Economic Research, Inc.
  4. Huixin Bi & Eric M. Leeper, 2010. "Sovereign Debt Risk Premia and Fiscal Policy in Sweden," NBER Working Papers 15810, National Bureau of Economic Research, Inc.
  5. Vincent Reinhart & Brian Sack, 2000. "The Economic Consequences of Disappearing Government Debt," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31(2), pages 163-220.
  6. Andreas Schabert & Sweder J.G. van Wijnbergen, 2011. "Sovereign Default and the Stability of Inflation Targeting Regimes," Tinbergen Institute Discussion Papers 11-064/2/ DSF20, Tinbergen Institute.
  7. 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.
  8. Vasco Curdia & Michael Woodford, 2008. "Credit Frictions and Optimal Monetary Policy," Discussion Papers 0809-02, Columbia University, Department of Economics.
  9. Mertens, Karel & Ravn, Morten O., 2010. "Fiscal Policy in an Expectations Driven Liquidity Trap," CEPR Discussion Papers 7931, C.E.P.R. Discussion Papers.
  10. Ana M. Aizcorbe & Arthur B. Kennickell & Kevin B. Moore, 2003. "Recent changes in U.S. family finances: evidence from the 1998 and 2001 Survey of Consumer Finances," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jan, pages 1-32.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. L’austérité plus que toujours en question
    by jcbriquet in Ressources pour économistes on 2012-04-17 11:32:27
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Cited by:
  1. Schleer, Frauke & Semmler, Willi, 2013. "Financial sector-output dynamics in the euro area: Non-linearities reconsidered," ZEW Discussion Papers 13-068, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  2. Gernot Müller & André Meier & Giancarlo Corsetti, 2012. "What Determines Government Spending Multipliers?," IMF Working Papers 12/150, International Monetary Fund.
  3. Corsetti, Giancarlo & Kuester, Keith & Meier, André & Müller, Gernot, 2013. "Sovereign risk and belief-driven fluctuations in the euro area," CEPR Discussion Papers 9723, C.E.P.R. Discussion Papers.
  4. Beetsma, Roel & Mavromatis, Kostas, 2014. "An analysis of eurobonds," Journal of International Money and Finance, Elsevier, vol. 45(C), pages 91-111.
  5. Gonzalo Caballero, 2013. "Effects of Fiscal and Monetary Policy in the Great Recession," Economies, MDPI, Open Access Journal, vol. 1(2), pages 15-18, September.

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