EconPapers    
Economics at your fingertips  
 

Sovereign Default and Monetary Policy Tradeoffs

Huixin Bi (), Eric Leeper () and Campbell Leith ()

No RWP 18-2, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: The paper is organized around the following question: when the economy moves from a debt-GDP level where the probability of default is nil to a higher level?the ?fiscal limit?? where the default probability is non-negligible, how do the effects of routine monetary operations designed to achieve macroeconomic stabilization change? We find that the specification of the monetary policy rule plays a critical role. Consider a central bank that targets the risky rate. When the economy is near its fiscal limit, a transitory monetary policy contraction leads to a sustained rise in inflation, even though monetary policy actively targets inflation and fiscal policy passively adjusts taxes to stabilize debt. If the central bank targets the risk-free rate, on the other hand, the same transitory monetary contraction keeps inflation under control, but leads output to contract for a prolonged period of time. The comparison shows that sovereign default risk put into sharp relief the tradeoff between inflation and output stabilization.

Keywords: Sovereign Debt Default; Fiscal Sustainability; Fiscal Limit (search for similar items in EconPapers)
JEL-codes: H60 H30 E62 E30 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2018-03-02, Revised 2018-03-02
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: Add references at CitEc
Citations: View citations in EconPapers (3) Track citations by RSS feed

Downloads: (external link)
https://doi.org/10.18651/RWP2018-02 https://doi.org/10.18651/RWP2018-02 (text/html)

Related works:
Journal Article: Sovereign Default and Monetary Policy Tradeoffs (2018) Downloads
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fedkrw:rwp18-02

Ordering information: This working paper can be ordered from

Access Statistics for this paper

More papers in Research Working Paper from Federal Reserve Bank of Kansas City Contact information at EDIRC.
Bibliographic data for series maintained by ().

 
Page updated 2020-11-30
Handle: RePEc:fip:fedkrw:rwp18-02