DP11646 Time-Consistent Fiscal Policy in a Debt Crisis
|Author(s):||Neele Lisabet Balke, Morten O Ravn|
|Publication Date:||November 2016|
|Keyword(s):||austerity, debt crisis, inequality, Sovereign debt, Time-consistent fiscal policy|
|JEL(s):||E20, E62, F34, F41|
|Programme Areas:||International Macroeconomics and Finance|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=11646|
We analyze time-consistent fiscal policy in a sovereign debt model. We consider a production economy that incorporates feedback from policy to output through employment, features inequality though unemployment, and in which the government lacks a commitment technology. The government's optimal policies play off wedges due to the lack of lump-sum taxes and the distortions that taxes and transfers introduce on employment. Lack of commitment matters during a debt crises -- episodes where the price of debt reacts elastically to the issuance of new debt. In normal times, the government sets procyclical taxes, transfers and public goods provision but in crisis times it is optimal to implement austerity policies which minimize the distortions deriving from default premia. Could a third party provide a commitment technology, austerity is no longer optimal.