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Optimal Fiscal Rules and Macroprudential Policies with Sovereign Default Risk

Gerard Maideu-Morera

No 24-1534, TSE Working Papers from Toulouse School of Economics (TSE)

Abstract: The European Sovereign debt crises (2010-2012) showcased how excessive private leverage can threaten sovereign debt sustainability, making the existing fiscal rules targeting only public debt insufficient. In this paper, I study the optimal joint design of fiscal rules and macroprudential policies with sovereign default risk. I first consider a stylized two-period model of a small open economy where both the local government and a representative household borrow internationally. A central authority internal-izes externalities from sovereign default by the local government and designs fiscal rules and macroprudential policies. The model yields two insights: (i) it provides a novel rationale for macroprudential policies, and (ii) sovereign debt limits that are a function of the quantity of private debt (private-debt-dependent fiscal rules) can im-plement the optimal allocation. Then, I generalize these results to a multiperiod model with heterogeneous households, aggregate risk, and a rich asset structure. Finally, I calibrate a quantitative version of the model to compute the private-debt-dependent fiscal rules and the size of the macroprudential wedges.

Keywords: Fiscal rules; macroprudential policy; sovereign default; endogenous borrowing constraints; economic unions (search for similar items in EconPapers)
JEL-codes: E44 F34 F41 F45 G28 (search for similar items in EconPapers)
Date: 2024-05
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-eec, nep-mac, nep-mon and nep-opm
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