Working Paper: CEPR ID: DP9163
Authors: Carlos Eduardo Gonalves; Bernardo Guimares
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.
Keywords: Fiscal Adjustment; IMF; Sovereign Debt; Sovereign Default; Time Inconsistency
JEL Codes: F33; F34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| lack of credible commitment by governments (H12) | suboptimal fiscal adjustments (E62) |
| suboptimal fiscal adjustments (E62) | likelihood of sovereign default (F34) |
| conditional lending at subsidized rates (G21) | tougher fiscal policies (E62) |
| tougher fiscal policies (E62) | reduced future default risks (G33) |
| presence of a lender with seniority (G21) | positively influence fiscal policy choices (E62) |
| presence of a lender with seniority (G21) | reduce default risks (G33) |