Preemptive Austerity with Rollover Risk

Juan Carlos Conesa and Timothy Kehoe

No 31828, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: E6 F3 F4 H2 H3 (search for similar items in EconPapers)
Date: 2023-11
New Economics Papers: this item is included in nep-opm and nep-pbe
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Published as Juan Carlos Conesa & Timothy J. Kehoe, 2024. "Preemptive austerity with rollover risk," Journal of International Economics, vol 150.

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