Fiscal Rules and Sovereign Default

Laura Alfaro and Fabio Kanczuk

No 23370, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Recurrent concerns over debt sustainability in emerging and developed nations have prompted renewed debate on the role of fiscal rules. Their optimality, however, remains unclear. We provide a quantitative analysis of fiscal rules in a standard model of sovereign debt accumulation and default modified to incorporate quasi-hyperbolic preferences. For reasons of political economy or aggregation of citizens' preferences, government preferences are present biased, resulting in over-accumulation of debt. Calibrating this parameter with values in the literature, the model can reproduce debt levels and frequency of default typical of emerging markets even if the household impatience parameter is calibrated to local interest rates. A quantitative exercise finds welfare gains of the optimal fiscal policy to be economically substantial, and the optimal rule to not entail a countercyclical fiscal policy. A simple debt rule that limits the maximum amount of debt is analyzed and compared to a simple deficit rule that limits the maximum amount of deficit per period. Whereas the deficit rule does not perform well, the debt rule yields welfare gains virtually equal to the optimal rule.

JEL-codes: F34 H63 (search for similar items in EconPapers)
Date: 2017-04
New Economics Papers: this item is included in nep-dge
Note: EFG IFM PE
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Citations: View citations in EconPapers (24)

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Working Paper: Fiscal Rules and Sovereign Default (2016)
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