Fiscal Stimulus Under Sovereign Risk

64 Pages Posted: 23 Sep 2019

See all articles by Javier Bianchi

Javier Bianchi

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Pablo Ottonello

University of Michigan at Ann Arbor - Department of Economics; National Bureau of Economic Research (NBER)

Ignacio Presno

Board of Governors of the Federal Reserve System

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Date Written: September 2019

Abstract

The excess procyclicality of fiscal policy is commonly viewed as a central malaise in emerging economies. We document that procyclicality is more pervasive in countries with higher sovereign risk and provide a model of optimal fiscal policy with nominal rigidities and endogenous sovereign default that can account for this empirical pattern. Financing a fiscal stimulus is costly for risky countries and can render countercyclical policies undesirable, even in the presence of large Keynesian stabilization gains. We also show that imposing austerity can backfire by exacerbating the exposure to default, but a well-designed "fiscal forward guidance" can help reduce the excess procyclicality.

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Suggested Citation

Bianchi, Javier and Ottonello, Pablo and Presno, Ignacio, Fiscal Stimulus Under Sovereign Risk (September 2019). NBER Working Paper No. w26307, Available at SSRN: https://ssrn.com/abstract=3458232

Javier Bianchi (Contact Author)

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

90 Hennepin Avenue
Minneapolis, MN 55480
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Pablo Ottonello

University of Michigan at Ann Arbor - Department of Economics ( email )

611 Tappan Street
Ann Arbor, MI 48109-1220
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National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
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Ignacio Presno

Board of Governors of the Federal Reserve System ( email )

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Washington, DC 20551
United States

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