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Expansionary Fiscal Consolidation Under Sovereign Risk

Author

Listed:
  • Carlos Esquivel

    (Rutgers University
    The World Bank Research Department)

Abstract

We study how debt limits can be expansionary in economies facing sovereign risk. We develop a sovereign debt model with capital accumulation, long-term debt, and fiscal rules that features two distortions: debt dilution and a pecuniary externality of private investment on spreads. The optimal debt limit increases capital accumulation due to lower sovereign risk, generating an economic expansion in the long run. Welfare gains are a result of lower sovereign spreads due to expectations about future borrowing and investment. We present evidence of a positive (negative) relation between debt limits and investment (spreads), consistent with the predictions of the model.

Suggested Citation

  • Carlos Esquivel, 2024. "Expansionary Fiscal Consolidation Under Sovereign Risk," Departmental Working Papers 202401, Rutgers University, Department of Economics.
    • Handle: RePEc:rut:rutres:202401
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    File URL: http://www.sas.rutgers.edu/virtual/snde/wp/2024-01.pdf
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    More about this item

    Keywords

    Fiscal Rules; Sovereign Debt; Expansionary Fiscal Consolidation;
    All these keywords.

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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