Discussion Paper Details

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Title: Sovereign default risk and commitment for fiscal adjustment

Author(s): Carlos Eduardo Gonçalves and Bernardo Guimarães

Publication Date: October 2012

Keyword(s): fiscal adjustment, IMF, sovereign debt, sovereign default and time inconsistency

Programme Area(s): International Macroeconomics

Abstract: 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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Bibliographic Reference

Gonçalves, C and Guimarães, B. 2012. 'Sovereign default risk and commitment for fiscal adjustment'. London, Centre for Economic Policy Research.