Fiscal Policy, Sovereign Risk, and Unemployment

Pablo Ottonello, Ignacio Presno and Javier Bianchi
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Ignacio Presno: Federal Reserve Board

No 1382, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: How should fiscal policy be conducted in the presence of default risk? We address this question using a sovereign default model with downward wage rigidity. An increase in government spending during a recession stimulates economic activity and reduces unemployment. Because the government lacks commitment to future debt repayments, expansionary fiscal policy increases sovereign spreads making the fiscal stimulus less desirable. We analyze the optimal fiscal policy and study quantitatively whether austerity or stimulus is optimal during an economic slump.

Date: 2017
New Economics Papers: this item is included in nep-dge and nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed017:1382

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