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Sovereign risk and belief-driven fluctuations in the euro area

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

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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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 61 (2014)
Issue (Month): C ()
Pages: 53-73

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Handle: RePEc:eee:moneco:v:61:y:2014:i:c:p:53-73
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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