Discussion paper

DP9163 Sovereign default risk and commitment for fiscal adjustment

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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Citation

Guimaraes, B (2012), ‘DP9163 Sovereign default risk and commitment for fiscal adjustment‘, CEPR Discussion Paper No. 9163. CEPR Press, Paris & London. https://cepr.org/publications/dp9163