Expansionary Fiscal Consolidation Under Sovereign Risk

Carlos Esquivel

Departmental Working Papers from Rutgers University, Department of Economics

Abstract: We study how debt limits can be expansionary in economies facing sovereign risk. We develop a sovereign debt model with capital accumulation, long-term debt, and fiscal rules that features two distortions: debt dilution and a pecuniary externality of private investment on spreads. The optimal debt limit increases capital accumulation due to lower sovereign risk, generating an economic expansion in the long run. Welfare gains are a result of lower sovereign spreads due to expectations about future borrowing and investment. We present evidence of a positive (negative) relation between debt limits and investment (spreads), consistent with the predictions of the model.

Keywords: Fiscal Rules; Sovereign Debt; Expansionary Fiscal Consolidation (search for similar items in EconPapers)
JEL-codes: F34 F41 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2024-11-12
New Economics Papers: this item is included in nep-dge, nep-fdg and nep-opm
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:rut:rutres:202401

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