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Fear of Hiking? Monetary Policy and Sovereign Risk

Author

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  • Wolf, Martin
  • Zessner-Spitzenberg, Leopold

Abstract

What are the implications of a monetary tightening in a currency union for sovereign default risk in a union member? We study this question in a quantitative sovereign default model and obtain two results. First, a monetary tightening reduces default risk in the union member when its debt/GDP ratio is below a critical threshold, driven by increased incentives to reduce the level of debt. Second, the monetary tightening increases default risk when debt/GDP is above the critical threshold. We quantify this "Fear of Hiking" zone and study its policy implications by applying our model to the euro area.

Suggested Citation

  • Wolf, Martin & Zessner-Spitzenberg, Leopold, 2021. "Fear of Hiking? Monetary Policy and Sovereign Risk," CEPR Discussion Papers 16837, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:16837
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    More about this item

    Keywords

    Monetary policy; Sovereign debt; Sovereign default; Spreads; Currency union; Monetary fiscal interaction;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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