Time-consistent fiscal policy in a debt crisis

Neele L. Balke and Morten Ravn

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

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.

Keywords: Time-consistent fiscal policy; sovereign debt; debt crisis; austerity (search for similar items in EconPapers)
JEL-codes: E20 E62 F34 F41 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2016-11
New Economics Papers: this item is included in nep-dge and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

Downloads: (external link)
http://eprints.lse.ac.uk/86174/ Open access version. (application/pdf)

Related works:
Working Paper: Time-Consistent Fiscal Policy in a Debt Crisis (2016)
Working Paper: Time-Consistent Fiscal Policy in a Debt Crisis (2016)
Working Paper: Time-Consistent Fiscal Policy in a Debt Crisis (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:86174

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