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Fiscal Imbalances, Inflation and Sovereign Default Dynamics

  • Guillard, Michel
  • Sosa Navarro, Ramiro

The central question this paper seeks to answer is how monetary policy might affect the equilibrium behavior of default and sovereign risk premium. The paper is based on �one-interest-rate� model. Public debt becomes risky due to an active fiscal policy, as in Uribe (2006), reflecting the fiscal authority’s limited ability to control primary surplus. The insolvency problem is due to a string of bad luck (negative shocks affecting primary surplus). But in contrast to Uribe’s results, as the sovereign debt cost increases (which result from weak primary surplus), default becomes anticipated and reflected by a rising country risk premium and default probability. The default is defined as reneging on a contractual agreement and so the decision is set by the fiscal authority. However, conflicting objectives between fiscal and monetary authority play an important role in leading fiscal authority to default on its liabilities. The characteristic of the government policy needed to restore the equilibrium after the default is also analyzed.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 24075.

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Date of creation: Dec 2009
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Handle: RePEc:pra:mprapa:24075
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  1. John H. Cochrane, 1999. "Portfolio Advice for a Multifactor World," NBER Working Papers 7170, National Bureau of Economic Research, Inc.
  2. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," NBER Working Papers 6442, National Bureau of Economic Research, Inc.
  3. Michael Woodford, 2001. "Fiscal Requirements for Price Stability," NBER Working Papers 8072, National Bureau of Economic Research, Inc.
  4. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
  5. McCallum, Bennett T., 1981. "Price level determinacy with an interest rate policy rule and rational expectations," Journal of Monetary Economics, Elsevier, vol. 8(3), pages 319-329.
  6. Bennett T. McCallum, 2001. "Should Monetary Policy Respond Strongly to Output Gaps?," NBER Working Papers 8226, National Bureau of Economic Research, Inc.
  7. Sosa Navarro, Ramiro, 2005. "Default Recovery Rates and Implied Default Probability Estimations: Evidence from the Argentinean Crisis," MPRA Paper 11054, University Library of Munich, Germany.
  8. Willem Buiter, 2000. "The Fallacy of the Fiscal Theory of the Price Level, Again," CESifo Working Paper Series 303, CESifo Group Munich.
  9. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  10. Woodford, Michael, 1995. "Price-level determinacy without control of a monetary aggregate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 43(1), pages 1-46, December.
  11. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  12. Martin Uribe, 2002. "A Fiscal Theory of Sovereign Risk," NBER Working Papers 9221, National Bureau of Economic Research, Inc.
  13. Marco Arena & Carmen Reinhart & Francisco Vázquez, 2006. "The Lending Channel in Emerging Economics: Are Foreign Banks Different?," NBER Working Papers 12340, National Bureau of Economic Research, Inc.
  14. Willem H. Buiter, 1999. "The Fallacy of the Fiscal Theory of the Price Level," NBER Working Papers 7302, National Bureau of Economic Research, Inc.
  15. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  16. Sims, Christopher A, 1994. "A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 4(3), pages 381-99.
  17. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 4(3), pages 345-80.
  18. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-54, April.
  19. Pau Rabanal, 2004. "Monetary Policy Rules and the U.S. Business Cycle; Evidence and Implications," IMF Working Papers 04/164, International Monetary Fund.
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