How diabolic is the sovereign-bank loop? The effects of post-default fiscal policies
Andre Diniz and
No 1705, Discussion Papers from Centre for Macroeconomics (CFM)
The deleterious effect of debt restructuring on banks' balance sheets and, consequently, on the economy as a whole has been a key policy issue. This paper studies how post-default fiscal policy interacts with this sovereign-bank loop and shape the response of a model economy. Calibration of the model matches characteristics of the Greek economy at the time of the Bond Exchange. Debt restructuring in place of higher lump-sum taxation or non-productive government spending harms the economy even if no other cost of default is considered. However, the sovereign-debt loop is less costly to the economy than increases in labour or capital taxes to service debt. Even so, if fiscal policy is too responsive, a crowding-out effect inhibits the recovery of capital markets, hence a more conservative fiscal stance is desirable. Thus how diabolic the post-default sovereign-bank loop is depends to a large extent on the way fiscal policy responds.
Keywords: Financial Frictions; Fiscal Policy; Soverign Default; Soverign-bank Loop (search for similar items in EconPapers)
JEL-codes: E32 E62 F34 G01 H63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fdg and nep-mac
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Working Paper: How diabolic is the sovereign-bank loop? The effects of post-default fiscal policies (2017)
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