Working Paper: NBER ID: w9932
Authors: Alejandro Neut; Andrés Velasco
Abstract: We revisit the question of what determines the credibility of macroeconomic policies here, of promises to repay public debt. Almost all thinking on the issue has focused on governments' strategic decision to default (or erode the value of outstanding debt via inflation/devaluation). But sometimes governments default not because they want to, but because they cannot avoid it: adverse shocks leave them no option. We build a model in which default/devaluation can occur deliberately (for strategic reasons) or unavoidably. If such unavoidable fiscal crises a) have pecuniary costs and b) occur with possible probability, much conventional wisdom on the determinantes of credibility need no longer hold. For instance, appointing a conservative policymaker or denominating public debt in foreign currency may reduce, not increase, credibility.
Keywords: No keywords provided
JEL Codes: E0; F0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government spending shocks (E62) | default likelihood (C51) |
| unexpected increases in expenditure or decreases in tax revenues (H69) | fiscal crises (H12) |
| fiscal crises (H12) | default or devaluation (F31) |
| higher share of dollarized indexed debt (F34) | larger devaluations required to restore fiscal solvency (H69) |
| higher costs associated with misbehavior (K42) | self-fulfilling crises (H12) |
| self-fulfilling crises (H12) | multiple equilibria with distinct expected rates of devaluation and social loss (D59) |
| policy rigidity and fiscal crises (H12) | expectations of devaluation (F31) |