Sovereign default risk, macroeconomic fluctuations and monetary-fiscal stabilisation

Markus Kirchner and Malte Rieth (mrieth@diw.de)

No 22/2020, IWH Discussion Papers from Halle Institute for Economic Research (IWH)

Abstract: This paper examines the role of sovereign default beliefs for macroeconomic fluctuations and stabilisation policy in a small open economy where fiscal solvency is a critical problem. We set up and estimate a DSGE model on Turkish data and show that accounting for sovereign risk significantly improves the fit of the model through an endogenous amplication between default beliefs, exchange rate and inflation movements. We then use the estimated model to study the implications of sovereign risk for stability, fiscal and monetary policy, and their interaction. We find that a relatively strong fiscal feedback from deficits to taxes, some exchange rate targeting, or a monetary response to default premia are more effective and efficient stabilisation tools than hawkish inflation targeting.

Keywords: small open economies; sovereign risk; monetary policy; exchange rates; business cycles; DSGE models (search for similar items in EconPapers)
JEL-codes: E58 E63 F41 (search for similar items in EconPapers)
Date: 2020
New Economics Papers: this item is included in nep-ara, nep-cba, nep-dge, nep-mac, nep-mon and nep-opm
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https://www.econstor.eu/bitstream/10419/226482/1/1741101573.pdf (application/pdf)

Related works:
Journal Article: Sovereign Default Risk, Macroeconomic Fluctuations and Monetary–Fiscal Stabilization (2021)
Working Paper: Sovereign Default Risk, Macroeconomic Fluctuations and Monetary-Fiscal Stabilization (2021)
Working Paper: Sovereign Default Risk, Macroeconomic Fluctuations and Monetary-Fiscal Stabilization (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:iwhdps:222020

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