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Preemptive Austerity with Rollover Risk

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  • Juan Carlos Conesa
  • Timothy J. Kehoe

Abstract

By preemptive austerity, we mean a policy that increases taxes to deter potential rollover crises. The policy is so successful that the usual danger signal of a rollover crisis, a high yield on new bonds sold, does not show up because the policy eliminates the danger. Mechanically, high taxes make the safe zone in the model - the set of sovereign debt levels for which the government prefers to repay its debt rather than default - larger. By announcing a high tax rate at the beginning of the period, the government ensures that tax revenue will be high enough to service sovereign debt becoming due, which deters panics by international lenders but is ex-post suboptimal. That is why, as it engages in preemptive austerity, the government continues to reduce the level of debt to a point where, asymptotically, high taxes are no longer necessary.

Suggested Citation

  • Juan Carlos Conesa & Timothy J. Kehoe, 2023. "Preemptive Austerity with Rollover Risk," Staff Report 654, Federal Reserve Bank of Minneapolis.
    • Handle: RePEc:fip:fedmsr:97226
    DOI: 10.21034/sr.654
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    References listed on IDEAS

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    More about this item

    Keywords

    Debt crises; Rollover crisis; Fiscal policy; Labor taxes; Eurozone;
    All these keywords.

    JEL classification:

    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • F30 - International Economics - - International Finance - - - General
    • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General
    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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