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Sovereign risk and belief-driven fluctuations in the euro area

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

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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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9723.

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Date of creation: Nov 2013
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Handle: RePEc:cpr:ceprdp:9723
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  1. Robert Kollmann & Werner Roeger & Jan in't Veld, 2012. "Fiscal Policy in a Financial Crisis: Standard Policy versus Bank Rescue Measures," American Economic Review, American Economic Association, vol. 102(3), pages 77-81, May.
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  3. Eduardo A. Cavallo & Patricio Valenzuela, 2007. "The Determinants of Corporate Risk in Emerging Markets: An Option-Adjusted Spread Analysis," IDB Publications (Working Papers) 6845, Inter-American Development Bank.
  4. Huixin Bi, 2011. "Sovereign Default Risk Premia, Fiscal Limits and Fiscal Policy," Working Papers 11-10, Bank of Canada.
  5. Robert E. Hall, 2009. "By How Much Does GDP Rise if the Government Buys More Output?," NBER Working Papers 15496, National Bureau of Economic Research, Inc.
  6. Corsetti, Giancarlo & Dedola, Luca, 2013. "The Mystery of the Printing Press: Self-fulfilling debt crises and monetary sovereignty," CEPR Discussion Papers 9358, C.E.P.R. Discussion Papers.
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  8. Philip R. Lane, 2012. "The European Sovereign Debt Crisis," Journal of Economic Perspectives, American Economic Association, vol. 26(3), pages 49-68, Summer.
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  11. Serkan Arslanalp & Yin Liao, 2013. "Contingent Liabilities and Sovereign Risk: Evidence from Banking Sectors," CAMA Working Papers 2013-43, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  12. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
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  14. Vasco Cúrdia & Michael Woodford, 2009. "Credit frictions and optimal monetary policy," BIS Working Papers 278, Bank for International Settlements.
  15. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Closing Small Open Economy Models," Departmental Working Papers 200115, Rutgers University, Department of Economics.
  16. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-Fulfilling Debt Crises," Levine's Working Paper Archive 114, David K. Levine.
  17. Michael Woodford, 2011. "Simple Analytics of the Government Expenditure Multiplier," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(1), pages 1-35, January.
  18. Giancarlo Corsetti & Keith Kuester & André Meier & Gernot J. Müller, 2013. "Sovereign Risk, Fiscal Policy, and Macroeconomic Stability," Economic Journal, Royal Economic Society, vol. 0, pages F99-F132, 02.
  19. In''t Veld, Jan & Kollmann, Robert & Ratto, Marco & Roeger, Werner, 2012. "Fiscal Policy, Banks and the Financial Crisis," CEPR Discussion Papers 9175, C.E.P.R. Discussion Papers.
  20. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, vol. 98(3), pages 690-712, June.
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  22. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-61, September.
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