Optimal fiscal policy and sovereign debt crises

Stefan Niemann and Paul Pichler (paul.pichler@univie.ac.at)

Review of Economic Dynamics, 2020, vol. 37, 234-254

Abstract: This paper studies how sovereign risk – both fundamental and self-fulfilling – shapes the cyclical behavior of optimal fiscal policy. We develop a model with endogenous default costs where market sentiment can induce belief-driven debt rollover crises. Optimal taxes and public spending are generally procyclical, but the incidence of rollover risk gives rise to infrequent episodes of severely countercyclical fiscal activity. These endogenous regime changes are associated with pronounced countercyclical changes in the level of debt. Debt buildups are triggered already by relatively mild recessions, but successful fiscal consolidations occur only in exceptionally good times. (Copyright: Elsevier)

Keywords: Fiscal policy; Sovereign debt; Rollover crises; Regime switches (search for similar items in EconPapers)
JEL-codes: E62 F34 H63 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (11)

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DOI: 10.1016/j.red.2020.02.003

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