Sovereign default risk and commitment for fiscal adjustment
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2015-01
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This paper studies fiscal policy in a model of sovereign debt and default A time inconsistency problem arises: since the price of past debt cannot be affected by current fiscal policy and governments cannot credibly commit to a certain path of tax rates, debtor countries choose suboptimally low fiscal adjustments. An international organization, capable of designing a contract that coaxes debtors into a tougher fiscal stance via the provision of cheap senior lending in times of crisis, can work as a commitment device and improve social welfare. (C) 2014 Published by Elsevier B.V.
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