Fear of Hiking? Monetary Policy and Sovereign Risk

Martin Wolf and Leopold Zessner-Spitzenberg

No 16837, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: What are the implications of a monetary tightening in a currency union for sovereign default risk in a union member? We study this question in a quantitative sovereign default model and obtain two results. First, a monetary tightening reduces default risk in the union member when its debt/GDP ratio is below a critical threshold, driven by increased incentives to reduce the level of debt. Second, the monetary tightening increases default risk when debt/GDP is above the critical threshold. We quantify this "Fear of Hiking" zone and study its policy implications by applying our model to the euro area.

Keywords: Monetary policy; Sovereign debt; Sovereign default; Spreads; Currency union; Monetary fiscal interaction (search for similar items in EconPapers)
JEL-codes: E52 F34 F41 (search for similar items in EconPapers)
Date: 2021-12
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