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DP9163 Sovereign default risk and commitment for fiscal adjustment

Author(s): Carlos Eduardo Gonçalves , Bernardo Guimarães
Publication Date: October 2012
Keyword(s): fiscal adjustment , IMF , sovereign debt , sovereign default , time inconsistency
JEL(s): F33 , F34
Programme Areas: International Macroeconomics
Link to this Page: www.cepr.org/pubs/dps/DP9163.asp


This paper studies fiscal policy in a model of sovereign debt and default. A time-inconsistency problem arises: since the price of past debt cannot be affected by current fiscal policy and governments cannot credibly commit to a certain path of tax rates, debtor countries choose suboptimally low fiscal adjustments. An international lender of last resort, capable of designing an implicit contract that coax debtors into a tougher fiscal stance via the provision of cheap (but senior) lending in times of crisis, can work as a commitment device and improve social welfare.

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