Fiscal Policy, Sovereign Default, and Bailouts
AbstractThis paper examines fiscal policy without commitment and the effects of conditional bailout loans. The government relies on distortionary taxation and decides between full debt repayment and costly default. It tends to overborrow due to myopia, which induces default to be a relevant policy option and provides a rationale to constrain sovereign borrowing. We consider a lump-sum financed fund that offers loans at a favorable price and conditional upon minimum primary surpluses. While the government prefers defaulting in the most adverse states, we find that it is willing to accept conditional loans in close-to-default states. These bailouts can lead to an increase in the mean debt price and a lower default probability that are associated with enhanced household welfare. Yet, these outcomes can be reversed when bailouts are too generous, while public debt never decreases in the long-run when bailout loans are available.
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Bibliographic InfoPaper provided by University of Cologne, Department of Economics in its series Working Paper Series in Economics with number 67.
Date of creation: 10 Dec 2013
Date of revision:
Discretionary fiscal policy; overborrowing; sovereign default; bailout loans; conditionality;
Other versions of this item:
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
- H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-12-15 (All new papers)
- NEP-CBA-2013-12-15 (Central Banking)
- NEP-MAC-2013-12-15 (Macroeconomics)
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