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Fiscal Commitment and Sovereign Default Risk

Siming Liu () and Hewei Shen

No 2018-003, CAEPR Working Papers from Center for Applied Economics and Policy Research, Department of Economics, Indiana University Bloomington

Abstract: This paper studies the effects of fiscal policy commitment in countries that suffer sovereign default risk. Since a government does not incorporate the effect of their taxation decisions on past bond prices, a time-inconsistency problem arises, resulting in too many defaults and too few fiscal adjustments. We show that a fiscal commitment device can mitigate the government’s default incentives and improve their borrowing opportunities. Moreover, instead of committing to a single tax rate, introducing a commitment device that depends on economic conditions can further reduce default risk while preserving the contingency of a pro-cyclical fiscal policy.

Keywords: overeign default risk; Pro-cyclical fiscal policy; Time-inconsistency; Fiscal commitment; Fiscal austerity (search for similar items in EconPapers)
JEL-codes: E62 F34 F41 (search for similar items in EconPapers)
Pages: 52 pages
Date: 2018-04
New Economics Papers: this item is included in nep-dge and nep-mac
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Journal Article: Fiscal Commitment and Sovereign Default Risk (2022) Downloads
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