Sovereign Risk, Fiscal Policy, and Macroeconomic Stability

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

No 2012/033, IMF Working Papers from International Monetary Fund

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: WP; monetary policy; risk premium; Fiscal policy; zero lower bound; sovereign risk; government spending; debt level; government debt; retrenchment package; credit market; ZLB episode; risk premia; Return on investment; Real interest rates; Europe; Global (search for similar items in EconPapers)
Pages: 56
Date: 2012-01-01
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Citations: View citations in EconPapers (48)

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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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