Fiscal Stimulus under Sovereign Risk

Javier Bianchi, Pablo Ottonello and Ignacio Presno

Journal of Political Economy, 2023, vol. 131, issue 9, 2328 - 2369

Abstract: What is the optimal fiscal policy response to a recession when the government is subject to sovereign risk? We study this question in a model of endogenous sovereign default with nominal rigidities. Increasing spending in a recession reduces unemployment, but it exposes the government to a debt crisis. We quantitatively analyze this trade-off between stimulus and austerity and find that expanding government spending may be undesirable, even in the presence of sizable Keynesian stabilization gains and inequality concerns. Consistent with these findings, we show that sovereign risk is a key driver of the fiscal procyclicality observed worldwide.

Date: 2023
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Related works:
Working Paper: Fiscal Stimulus Under Sovereign Risk (2019)
Working Paper: Fiscal Stimulus under Sovereign Risk (2019)
Working Paper: Fiscal Stimulus under Sovereign Risk (2019)
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