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Central bank independence and sovereign default

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  • Kocherlakota, N.

Abstract

This article relaxes the assumption usually assumed in the existing literature that the fiscal authority will never default on obligations issued on its own currency. It shows that a sufficiently tough central bank does have the ability to control the price level, regardless of the behaviour of the fiscal authority. In order to achieve independent control of the price level where the debt of the fiscal authority is defaultable, the central bank should be willing to allow the fiscal authority to default on its debt. However such a commitment to letting the fiscal authority default may expose the country to risks of short-term and medium-term output losses. How this trade-off should best be resolved deserves further research. But it may turn out to be optimal for central banks to guarantee fiscal authority debts in some situations.

Suggested Citation

  • Kocherlakota, N., 2012. "Central bank independence and sovereign default," Financial Stability Review, Banque de France, issue 16, pages 151-154, April.
    • Handle: RePEc:bfr:fisrev:2011:16:14
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    References listed on IDEAS

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    3. Jonathan Eaton & Mark Gersovitz, 1987. "Country Risk and the Organization of International Capital Transfer," NBER Working Papers 2204, National Bureau of Economic Research, Inc.
    4. Cochrane, John H., 2005. "Money as stock," Journal of Monetary Economics, Elsevier, vol. 52(3), pages 501-528, April.
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    Cited by:

    1. López-Martín, Bernabé & Ramírez de Aguilar, Alberto & Samano, Daniel, 2018. "Fiscal Policy and Inflation: Understanding the Role of Expectations in Mexico," IDB Publications (Working Papers) 9025, Inter-American Development Bank.
    2. Jean Barthélemy & Guillaume Plantin, 2018. "Fiscal and Monetary Regime: A Strategic Approach," SciencePo Working papers hal-03815028, HAL.
    3. Gita Gopinath, 2011. "EconomicDynamics Interviews Gita Gopinath on Sovereign Default," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 13(1), November.

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