A Fiscal Theory of Sovereign Risk

29 Pages Posted: 6 Aug 2003

See all articles by Martín Uribe

Martín Uribe

Columbia University - Graduate School of Arts and Sciences - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: November 9, 2003

Abstract

This paper presents a fiscal theory of sovereign risk and default. Under certain monetary-fiscal regimes, the risk of default, and thus the emergence of sovereign risk premia, are inevitable. The paper characterizes the equilibrium processes of the sovereign risk premium and the default rate under a number of alternative monetary policy arrangements. It is argued that, given the fiscal stance, monetary policy plays a crucial role in shaping the equilibrium behaviour of the country risk premium and the default rate. For instance, under some of the monetary policy rules considered, the expected default rate and the sovereign risk premium are zero (and therefore unforecastable) although the government defaults regularly. Under other monetary regimes the default rate and the sovereign risk premium are serially correlated (and therefore forecastable). In addition, environments are characterized under which delaying default is counterproductive.

Keywords: default, sovereign risk, public debt

JEL Classification: E6, F41

Suggested Citation

Uribe, Martin, A Fiscal Theory of Sovereign Risk (November 9, 2003). Available at SSRN: https://ssrn.com/abstract=288998

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