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Time-consistent fiscal policy in a debt crisis

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  • Balke, Neele L.
  • Ravn, Morten O.

Abstract

We analyze time-consistent fiscal policy in a sovereign debt model. We consider a production economy that incorporates feedback from policy to output through employment, features inequality though unemployment, and in which the government lacks a commitment technology. The government’s optimal policies play off wedges due to the lack of lumpsum taxes and the distortions that taxes and transfers introduce on employment. Lack of commitment matters during a debt crises – episodes where the price of debt reacts elastically to the issuance of new debt. In normal times, the government sets procyclical taxes, transfers and public goods provision but in crisis times it is optimal to implement austerity policies which minimize the distortions deriving from default premia. Could a third party provide a commitment technology, austerity is no longer optimal.

Suggested Citation

  • Balke, Neele L. & Ravn, Morten O., 2016. "Time-consistent fiscal policy in a debt crisis," LSE Research Online Documents on Economics 86174, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:86174
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    File URL: http://eprints.lse.ac.uk/86174/
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    Cited by:

    1. Prein, Timm, 2019. "Persistent Unemployment, Sovereign Debt Crises, and the Impact of Haircuts," VfS Annual Conference 2019 (Leipzig): 30 Years after the Fall of the Berlin Wall - Democracy and Market Economy 203654, Verein für Socialpolitik / German Economic Association.
    2. Mihaela Onofrei & Tudorel Toader & Anca Florentina Vatamanu & Florin Oprea, 2021. "Impact of Governments’ Fiscal Behaviors on Public Finance Sustainability: A Comparative Study," Sustainability, MDPI, Open Access Journal, vol. 13(7), pages 1-16, March.
    3. Dioikitopoulos, Evangelos V., 2018. "Dynamic adjustment of fiscal policy under a debt crisis," Journal of Economic Dynamics and Control, Elsevier, vol. 93(C), pages 260-276.
    4. Andreasen, Eugenia & Sandleris, Guido & Van der Ghote, Alejandro, 2019. "The political economy of sovereign defaults," Journal of Monetary Economics, Elsevier, vol. 104(C), pages 23-36.
    5. Neele Balke, 2018. "The Employment Cost of Sovereign Default," 2018 Meeting Papers 1256, Society for Economic Dynamics.

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    More about this item

    Keywords

    Time-consistent fiscal policy; sovereign debt; debt crisis; austerity;
    All these keywords.

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal 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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