Preemptive Austerity with Rollover Risk

Juan Carlos Conesa and Timothy Kehoe

No 654, Staff Report from Federal Reserve Bank of Minneapolis

Abstract: By preemptive austerity, we mean a policy that increases taxes to deter potential rollover crises. The policy is so successful that the usual danger signal of a rollover crisis, a high yield on new bonds sold, does not show up because the policy eliminates the danger. Mechanically, high taxes make the safe zone in the model - the set of sovereign debt levels for which the government prefers to repay its debt rather than default - larger. By announcing a high tax rate at the beginning of the period, the government ensures that tax revenue will be high enough to service sovereign debt becoming due, which deters panics by international lenders but is ex-post suboptimal. That is why, as it engages in preemptive austerity, the government continues to reduce the level of debt to a point where, asymptotically, high taxes are no longer necessary.

Keywords: Debt crises; Rollover crisis; Fiscal policy; Labor taxes; Eurozone (search for similar items in EconPapers)
JEL-codes: E60 F30 F40 H20 H30 (search for similar items in EconPapers)
Date: 2023-10-30
New Economics Papers: this item is included in nep-opm
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Related works:
Journal Article: Preemptive austerity with rollover risk (2024)
Working Paper: Preemptive Austerity with Rollover Risk (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedmsr:97226

DOI: 10.21034/sr.654

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