Optimal fiscal policy when agents fear government default

Francesco Caprioli (), Pietro Rizza () and Pietro Tommasino
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Francesco Caprioli: Bank of Italy

No 859, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: We derive the optimal fiscal policy for a government that is committed to honoring its debt but faces investors which fear a sovereign default. We assume that investors are able to learn from new evidence, as in Marcet and Sargent (1989), so that they can gradually correct their overly pessimistic view about the government's creditworthiness. We show that in an economy with these features, contrary to the prescriptions of standard models, a frontloaded fiscal consolidation after an adverse fiscal shock is optimal.

Keywords: Ramsey-optimal fiscal policy; non-contingent public debt; learning. (search for similar items in EconPapers)
JEL-codes: D83 E62 (search for similar items in EconPapers)
Date: 2012-03
New Economics Papers: this item is included in nep-dge
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Journal Article: Optimal Fiscal Policy when Agents Fear Government Default (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:bdi:wptemi:td_859_12

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