Sovereign Default and the Stability of Inflation Targeting Regimes

Andreas Schabert and Sweder van Wijnbergen

Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: This discussion paper resulted in a publication in the 'IMF Economic Review' , 2014, 62(2), 261-287.

We analyse the impact of interactions between monetary and fiscal policy on macroeconomic stability. We find that in the presence of sovereign default beliefs a monetary policy, which aims to stabilize inflation through an active interest rate policy, will destabilize the economy if the feedback from debt surprises back to the primary surplus is too weak. This result, which relies on endogenous changes in the default premium, is at odds with the results in an environment without default risk, where an active monetarypolicy guarantees macroeconomic stability. The results are highly relevant for the design of fiscal and monetary policy in emerging markets where sovereign credibility is not well established. Recent debt developments in Western Europe and in the US suggest these results might become relevant for more mature financial markets too.

Keywords: Inflation targeting; fiscal-monetary policy interactions; sovereign default risk; foreign debt (search for similar items in EconPapers)
JEL-codes: E52 E63 F41 (search for similar items in EconPapers)
Date: 2011-04-12
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Journal Article: Sovereign Default and the Stability of Inflation-Targeting Regimes (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20110064

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