Fiscal Stimulus Under Sovereign Risk

63 Pages Posted: 22 Oct 2019 Last revised: 29 Apr 2020

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

Multiple version iconThere are 2 versions of this paper

Date Written: 2019-09-20

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.

Keywords: Fiscal Stabilization Policy, Sovereign Default, Procyclicality

JEL Classification: E62, F34, F41, F44, H50

Suggested Citation

Bianchi, Javier and Ottonello, Pablo and Presno, Ignacio, Fiscal Stimulus Under Sovereign Risk (2019-09-20). FRB International Finance Discussion Paper No. 1257, Available at SSRN: https://ssrn.com/abstract=3473068 or http://dx.doi.org/10.17016/IFDP.2019.1257

Javier Bianchi (Contact Author)

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

90 Hennepin Avenue
Minneapolis, MN 55480
United States

Pablo Ottonello

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

611 Tappan Street
Ann Arbor, MI 48109-1220
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ignacio Presno

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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