Sovereign Default Risk, Macroeconomic Fluctuations and Monetary-Fiscal Stabilization.

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Date: June 2021
From: IMF Economic Review(Vol. 69, Issue 2)
Publisher: Palgrave Macmillan Ltd. (Springer)
Document Type: Report
Length: 13,696 words
Lexile Measure: 1560L

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Abstract :

This paper examines the role of sovereign default beliefs for macroeconomic fluctuations and stabilization policy in a small open economy where fiscal solvency is a critical problem. We set up and estimate a DSGE model on Turkish data and show that accounting for sovereign risk significantly improves the fit of the model through an endogenous amplification between default beliefs, exchange rate and inflation movements. We then use the estimated model to study the implications of sovereign risk for stability, fiscal and monetary policy, and their interaction. We find that a relatively strong fiscal feedback from deficits to taxes, some exchange rate targeting or a monetary response to default premia are more effective and efficient stabilization tools than hawkish inflation targeting. JEL Classification E58 * E63 * F41

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Gale Document Number: GALE|A666229974