Fiscal Stimulus under Sovereign Risk
What is the optimal fiscal policy response to a recession when the government is subject to sovereign risk? We study this question in a model of endogenous sovereign default with nominal rigidities. Increasing spending in a recession reduces unemployment, but exposes the government to a debt crisis. We quantitatively analyze this trade-off between stimulus and austerity and find that expanding government spending may be undesirable, even in the presence of sizeable Keynesian stabilization gains and inequality concerns. Consistent with these findings, we show that sovereign risk is a key driver of the fiscal procyclicality observed worldwide.
Published Versions
Javier Bianchi & Pablo Ottonello & Ignacio Presno, 2023. "Fiscal Stimulus under Sovereign Risk," Journal of Political Economy, vol 131(9), pages 2328-2369.
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