Sovereign Risk and Belief-Driven Fluctuations in the Euro Area

51 Pages Posted: 8 Nov 2013

See all articles by Giancarlo Corsetti

Giancarlo Corsetti

University of Cambridge; University of Rome III - Department of Economics; Centre for Economic Policy Research (CEPR)

Keith Kuester

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Andre Meier

International Monetary Fund (IMF)

Gernot J. Müller

University of Tuebingen - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: November 2013

Abstract

Sovereign risk premia in several euro area countries have risen markedly since 2008, driving up credit spreads in the private sector as well. We propose a New Keynesian model of a two-region monetary union that accounts for this "sovereign risk channel." The model is calibrated to the euro area as of mid-2012. We show that a combination of sovereign risk in one region and strongly procyclical fiscal policy at the aggregate level exacerbates the risk of belief-driven deflationary downturns. The model provides an argument in favor of coordinated, asymmetric fiscal stances as a way to prevent self-fulfilling debt crises.

Keywords: euro area, monetary union, pooling of sovereign risk, risk premium, sovereign risk channel, zero lower bound

JEL Classification: E62, F41, F42

Suggested Citation

Corsetti, Giancarlo and Kuester, Keith and Meier, Andre and Müller, Gernot J., Sovereign Risk and Belief-Driven Fluctuations in the Euro Area (November 2013). CEPR Discussion Paper No. DP9723, Available at SSRN: https://ssrn.com/abstract=2351330

Giancarlo Corsetti (Contact Author)

University of Cambridge ( email )

University of Rome III - Department of Economics ( email )

via Ostiense 139
Rome, 00154
Italy
+39 06 5737 4056 (Phone)
+39 06 5737 4093 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Keith Kuester

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Andre Meier

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Gernot J. Müller

University of Tuebingen - Department of Economics ( email )

Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
0
Abstract Views
300
PlumX Metrics