Fiscal Stimulus Under Sovereign Risk

86 Pages Posted: 23 Sep 2019 Last revised: 20 May 2023

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

What is the optimal fiscal policy response to a recession when the government is subject to sovereign risk? We study this question in a model of endogenous sovereign default with nominal rigidities. Increasing spending in a recession reduces unemployment, but exposes the government to a debt crisis. We quantitatively analyze this trade-off between stimulus and austerity and find that expanding government spending may be undesirable, even in the presence of sizeable Keynesian stabilization gains and inequality concerns. Consistent with these findings, we show that sovereign risk is a key driver of the fiscal procyclicality observed worldwide.

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 )

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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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