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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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File URL: http://www.sciencedirect.com/science/article/pii/S0304393213001475
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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
DOI: 10.1016/j.jmoneco.2013.11.001
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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  13. Curdia, Vasco & Woodford, Michael, 2015. "Credit frictions and optimal monetary policy," Working Paper Series 2015-20, Federal Reserve Bank of San Francisco, revised 10 Dec 2015.
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  17. Robert E. Hall, 2009. "By How Much Does GDP Rise if the Government Buys More Output?," NBER Working Papers 15496, National Bureau of Economic Research, Inc.
  18. Nathalie Girouard & Christophe André, 2005. "Measuring Cyclically-adjusted Budget Balances for OECD Countries," OECD Economics Department Working Papers 434, OECD Publishing.
  19. 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) 170, Bank of Italy, Economic Research and International Relations Area.
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