Fiscal Policy, Sovereign Default, and Bailouts

Falko Juessen and Andreas Schabert

No 67, Working Paper Series in Economics from University of Cologne, Department of Economics

Abstract: This paper examines fiscal policy without commitment and the effects of conditional bailout loans. The government relies on distortionary taxation and decides between full debt repayment and costly default. It tends to overborrow due to myopia, which induces default to be a relevant policy option and provides a rationale to constrain sovereign borrowing. We consider a lump-sum financed fund that offers loans at a favorable price and conditional upon minimum primary surpluses. While the government prefers defaulting in the most adverse states, we find that it is willing to accept conditional loans in close-to-default states. These bailouts can lead to an increase in the mean debt price and a lower default probability that are associated with enhanced household welfare. Yet, these outcomes can be reversed when bailouts are too generous, while public debt never decreases in the long-run when bailout loans are available.

Keywords: Discretionary fiscal policy; overborrowing; sovereign default; bailout loans; conditionality (search for similar items in EconPapers)
JEL-codes: E32 H21 H63 (search for similar items in EconPapers)
Date: 2013-12-10
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 (9)

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Working Paper: Fiscal Policy, Sovereign Default, and Bailouts (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:kls:series:0067

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