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Sovereign default risk and commitment for fiscal adjustment

  • Gonçalves, Carlos Eduardo
  • Guimarães, Bernardo

This paper studies fiscal policy in a model of sovereign debt and default. A time-inconsistency problem arises: since the price of past debt cannot be affected by current fiscal policy and governments cannot credibly commit to a certain path of tax rates, debtor countries choose suboptimally low fiscal adjustments. An international lender of last resort, capable of designing an implicit contract that coax debtors into a tougher fiscal stance via the provision of cheap (but senior) lending in times of crisis, can work as a commitment device and improve social welfare.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9163.

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Date of creation: Oct 2012
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Handle: RePEc:cpr:ceprdp:9163
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