Working Paper: NBER ID: w31828
Authors: Juan Carlos Conesa; Timothy J. Kehoe
Abstract: By preemptive austerity, we mean a policy that increases taxes to deter potential rollover crises. The policy is so successful that the usual danger signal of a rollover crisis, a high yield on new bonds sold, does not show up because the policy eliminates the danger. Mechanically, high taxes make the safe zone in the model — the set of sovereign debt levels for which the government prefers to repay its debt rather than default — larger. By announcing a high tax rate at the beginning of the period, the government ensures that tax revenue will be high enough to service sovereign debt becoming due, which deters panics by international lenders but is ex-post suboptimal. That is why, as it engages in preemptive austerity, the government continues to reduce the level of debt to a point where, asymptotically, high taxes are no longer necessary.
Keywords: preemptive austerity; sovereign debt; rollover risk; fiscal policy
JEL Codes: E6; F3; H2; H3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| preemptive austerity (high pre-announced tax rates) (E65) | avoidance of lender panics (G21) |
| high tax rates (H29) | sufficient tax revenue to service maturing debt (H63) |
| sufficient tax revenue (H20) | government prefers to repay its debt rather than default (H63) |
| government prefers to repay its debt rather than default (H63) | avoidance of rollover crises (F65) |
| high tax rates (H29) | lender confidence and access to credit (G21) |
| absence of preemptive austerity (H69) | higher interest rates and potential default (E43) |