Central bank independence and sovereign default

Narayana Kocherlakota

Financial Stability Review, 2012, issue 16, 151-154

Abstract: This article relaxes the assumption usually assumed in the existing literature that the fiscal authority will never default on obligations issued on its own currency. It shows that a sufficiently tough central bank does have the ability to control the price level, regardless of the behaviour of the fiscal authority. In order to achieve independent control of the price level where the debt of the fiscal authority is defaultable, the central bank should be willing to allow the fiscal authority to default on its debt. However such a commitment to letting the fiscal authority default may expose the country to risks of short-term and medium-term output losses. How this trade-off should best be resolved deserves further research. But it may turn out to be optimal for central banks to guarantee fiscal authority debts in some situations.

Date: 2012
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Persistent link: https://EconPapers.repec.org/RePEc:bfr:fisrev:2011:16:14

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