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Sovereign Risk and Belief-Driven Fluctuations in the Euro Area

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Author Info

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

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 selffulfilling debt crises.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 13/227.

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Length: 49
Date of creation: 06 Nov 2013
Date of revision:
Handle: RePEc:imf:imfwpa:13/227

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Keywords: Sovereign debt; Euro Area; Fiscal risk; Risk premium; Fiscal policy; Monetary policy; Economic models; Sovereign risk channel; monetary union; zero lower bound; risk premium; pooling of sovereign risk; government spending; fiscal stance; spending cuts; tax revenue; fiscal multiplier; aggregate demand; government expenditure; public debt; fiscal expansion; fiscal stress; fiscal austerity; public finances; fiscal impulse; fiscal outlook; fiscal response; fiscal policies; government deficit; fiscal stances; tax systems; fiscal risks; government budget; fiscal deficits; taxation; fiscal transfer; public expenditures; budget constraint; primary expenditure; fiscal theory; fiscal limits; expansionary fiscal; expansionary fiscal policies; budget deficits; fiscal position; tax revenues; debt obligations; fiscal consolidation; primary deficit; future fiscal deficits; budget balances; fiscal conditions; fiscal impulses;

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References

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  1. 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, American Economic Association, vol. 102(3), pages 77-81, May.
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  3. Vasco Curdia & Michael Woodford, 2008. "Credit Frictions and Optimal Monetary Policy," Discussion Papers, Columbia University, Department of Economics 0809-02, Columbia University, Department of Economics.
  4. Arellano, Cristina, 2008. "Default risk and income fluctuations in emerging economies," MPRA Paper 7867, University Library of Munich, Germany.
  5. Yeyati, Eduardo Levy & Panizza, Ugo, 2011. "The elusive costs of sovereign defaults," Journal of Development Economics, Elsevier, Elsevier, vol. 94(1), pages 95-105, January.
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  11. Robert Kollmann & Marco Ratto & Werner Roeger & Jan in't Veld, 2012. "Fiscal policy, banks and the financial crisis," Working Paper Research, National Bank of Belgium 234, National Bank of Belgium.
  12. Keith Kuester & Gernot J. Mueller & Giancarlo Corsetti & André Meier, 2012. "Sovereign Risk, Fiscal Policy, and Macroeconomic Stability," IMF Working Papers 12/33, International Monetary Fund.
  13. 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), Bank of Italy, Economic Research and International Relations Area 170, Bank of Italy, Economic Research and International Relations Area.
  14. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, American Economic Association, vol. 78(4), pages 647-61, September.
  15. 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., John Wiley & Sons, Ltd., vol. 15(1), pages 59-74.
  16. Albertazzi, Ugo & Ropele, Tiziano & Sene, Gabriele & Signoretti, Federico Maria, 2014. "The impact of the sovereign debt crisis on the activity of Italian banks," Journal of Banking & Finance, Elsevier, Elsevier, vol. 46(C), pages 387-402.
  17. Edda Zoli, 2013. "Italian Sovereign Spreads," IMF Working Papers 13/84, International Monetary Fund.
  18. 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.
  19. 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.
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  22. Corsetti, Giancarlo & Dedola, Luca, 2013. "The Mystery of the Printing Press: Self-fulfilling debt crises and monetary sovereignty," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9358, C.E.P.R. Discussion Papers.
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Cited by:
  1. repec:spo:wpecon:info:hdl:2441/2g7mhju69b94obeaqlen09s1au is not listed on IDEAS
  2. 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.

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