Sovereign Risk, Fiscal Policy, and Macroeconomic Stability

Giancarlo Corsetti, Müller, Gernot, Keith Kuester and Andre Meier
Authors registered in the RePEc Author Service: Gernot J. Müller

No 8779, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper analyzes the impact of strained government finances on macroeconomic stability and the transmission of fiscal policy. Using a variant of the model by Curdia and Woodford (2009), we study a 'sovereign risk channel' through which sovereign default risk raises funding costs in the private sector. If monetary policy is constrained, the sovereign risk channel exacerbates indeterminacy problems: private-sector beliefs of a weakening economy may become self-fulfilling. In addition, sovereign risk amplifies the effects of negative cyclical shocks. Under those conditions, fiscal retrenchment can help curtail the risk of macroeconomic instability and, in extreme cases, even stimulate economic activity.

Keywords: Fiscal policy; Monetary policy; risk premium; Sovereign risk; Zero lower bound (search for similar items in EconPapers)
JEL-codes: E32 E52 E62 (search for similar items in EconPapers)
Date: 2012-01
New Economics Papers: this item is included in nep-cba and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (53)

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Related works:
Journal Article: Sovereign Risk, Fiscal Policy, and Macroeconomic Stability (2013)
Working Paper: Sovereign Risk, Fiscal Policy, and Macroeconomic Stability (2012)
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