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Sovereign risk and belief-driven fluctuations in the euro area

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

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 self-fulfilling debt crises.

Suggested Citation

  • Corsetti, Giancarlo & Kuester, Keith & Meier, André & Müller, Gernot J., 2014. "Sovereign risk and belief-driven fluctuations in the euro area," Journal of Monetary Economics, Elsevier, vol. 61(C), pages 53-73.
  • Handle: RePEc:eee:moneco:v:61:y:2014:i:c:p:53-73
    DOI: 10.1016/j.jmoneco.2013.11.001
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    References listed on IDEAS

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    More about this item

    Keywords

    Sovereign risk channel; Monetary union; Euro area; Zero lower bound; Risk premium; Pooling of sovereign risk;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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