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Optimal Fiscal Policy when Agents Fear Government Default

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  • Francesco Caprioli
  • Pietro Rizza
  • Pietro Tommasino

Abstract

We derive the optimal fiscal policy for a government which is committed to honour its debts but faces investors which fear that a sovereign default might instead happen. We assume that investors are able to learn from new evidence, as in Marcet and Sargent (1989), so that they can correct over time their overly pessimistic view about government?s creditworthiness. We show that in this economy, contrary to the prescriptions of standard models, a frontloaded fiscal consolidation after an adverse fiscal shock is optimal.

Suggested Citation

  • Francesco Caprioli & Pietro Rizza & Pietro Tommasino, 2011. "Optimal Fiscal Policy when Agents Fear Government Default," Revue économique, Presses de Sciences-Po, vol. 62(6), pages 1031-1043.
    • Handle: RePEc:cai:recosp:reco_626_1031
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. What to do when people expect the government to default on its debt
      by Economic Logician in Economic Logic on 2012-05-16 19:13:00

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    More about this item

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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