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Sovereign risk and belief-driven fluctuations in the euro area

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Listed author(s):
  • 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.

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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

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

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Find related papers by 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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  2. Ugo Panizza & Federico Sturzenegger & Jeromin Zettelmeyer, 2009. "The Economics and Law of Sovereign Debt and Default," Journal of Economic Literature, American Economic Association, vol. 47(3), pages 651-698, September.
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