Sovereign Debt Risk Premia and Fiscal Policy in Sweden

Working Paper: NBER ID: w15810

Authors: Huixin Bi; Eric M. Leeper

Abstract: This paper takes a step toward providing a general equilibrium framework within which to study the nub of the current fiscal debate around the world: what are the tradeoffs between short-run stabilization and long-run sustainability when the perceived riskiness of government debt depends, in part, on the current and expected fiscal environment in place? We calibrate a simple model to Swedish fiscal data in two periods: before and after the financial crisis of the early 1990s. We compute the dynamic fiscal limit, which depends on the peak of the Laffer curve, for the pre-crisis and three alternative post-crisis fiscal policies. The model simulates the macroeconomic consequences of alternative policies in the face of the sequence of bad output shocks that Sweden experienced from 1991-1997.

Keywords: Sovereign Debt; Fiscal Policy; Risk Premia; Sweden

JEL Codes: E6; E62; H2; H5; H6

Causal Claims

Cause	Effect
Fiscal policy (E62)	Perceived riskiness of government debt (H63)
Sound fiscal policies (E62)	Risk premia associated with sovereign debt (H63)
Adopting fiscal rules (E62)	Shift in the economy's fiscal limit (E62)
Shift in the economy's fiscal limit (E62)	Likelihood of sovereign debt being assessed a risk premium (F34)
Countercyclical fiscal policies (E62)	Risk of default (G33)
Procyclical fiscal policies (E62)	Risk of default (G33)
Higher levels of debt (H63)	Increased risk premia (G19)
Implementation of an expenditure ceiling (H61)	Stabilization of the fiscal environment (E63)
Fiscal discipline (E62)	Lower risk assessments by financial markets (G19)
Lower risk assessments by financial markets (G19)	Interest rates on government bonds (E43)
Willingness of the government to service its debt (H63)	Fiscal sustainability (H68)
Fiscal sustainability (H68)	Default probabilities (C11)