Sovereign Risk Fiscal Policy And Macroeconomic Stability
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Sovereign Risk, Fiscal Policy, and Macroeconomic Stability
Author | : Giancarlo Corsetti |
Publisher | : International Monetary Fund |
Total Pages | : 56 |
Release | : 2012-01-01 |
Genre | : Business & Economics |
ISBN | : 1463977077 |
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This paper analyzes the impact of strained government finances on macroeconomic stability and the transmission of fiscal policy. Using a variant of the model by Curdia and Woodford (2009), we study a "sovereign risk channel" through which sovereign default risk raises funding costs in the private sector. If monetary policy is constrained, the sovereign risk channel exacerbates indeterminacy problems: private-sector beliefs of a weakening economy may become self-fulfilling. In addition, sovereign risk amplifies the effects of negative cyclical shocks. Under those conditions, fiscal retrenchment can help curtail the risk of macroeconomic instability and, in extreme cases, even stimulate economic activity.
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