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Signalling Debt Sustainability

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  • Drudi, Francesco
  • Prati, Alessandro

Abstract

This paper studies the optimal debt repayment policy of a government facing a credibility problem: the public is uncertain about whether the outstanding public debt will be repaid in full or in part and requires a risk premium to roll it over. The model determines when it is optimal for the government in power to signal the sustainability (full repayment) or the non-sustainability (partial repayment) of the debt regime. The timing depends on the initial reputation of the government, the costs of taxing labour income, and the costs of defaulting on government debt, which are endogenized as a function of the redistributive preferences of the government. In the presence of a deficit net of interest payments, the uncertainty may or may not be resolved, but it will always be resolved when a lasting surplus net of interest payments is achieved. The model allows an evaluation of the deficit and the debt prerequisites for EMU set by the Maastricht Treaty: they are sufficient to exclude potentially defaulting governments, but may be excessively strict for this purpose.

Suggested Citation

  • Drudi, Francesco & Prati, Alessandro, 1993. "Signalling Debt Sustainability," CEPR Discussion Papers 787, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:787
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    Citations

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    Cited by:

    1. Heinemann, Friedrich, 1998. "The EMU Consolidation Game - or: Does 3.0 Really Mean 3.0?," ZEW Discussion Papers 98-01, ZEW - Leibniz Centre for European Economic Research.
    2. Drudi, Francesco & Prati, Alessandro, 2000. "Signaling fiscal regime sustainability," European Economic Review, Elsevier, vol. 44(10), pages 1897-1930, December.

    More about this item

    Keywords

    Default; EMU; Maastricht; Stabilization; Sustainability;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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