Sovereign default risk and commitment for fiscal adjustment

Available from: 
October 2013
Paper author(s): 
Bernardo Guimaraes (Sao Paulo School of Economics)
Carlos Goncalves (Universidade de Sao Paulo)
Macroeconomics - Economic growth - Monetary Policy

This paper studies fiscal policy in a model of sovereign debt and default. A time-inconsistency problem arises: since the price of past debt cannot be affected by current fiscal policy and governments cannot credibly commit to a certain path of tax rates, debtor countries choose suboptimally low fiscal adjustments. An international lender of last resort, capable of designing an implicit contract that coax debtors into a tougher fiscal stance via the provision of cheap (but senior) lending in times of crisis, can work as a commitment device and improve social welfare.


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Research section: 
Lacea 2013 annual meeting
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