Sovereign Risk and Belief-Driven Fluctuations in the Euro Area
November 6, 2013
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Summary
Sovereign risk premia in several euro area countries have risen markedly since 2008, driving up credit spreads in the private sector as well. We propose a New Keynesian model of a two-region monetary union that accounts for this “sovereign risk channel.” The model is calibrated to the euro area as of mid-2012. We show that a combination of sovereign risk in one region and strongly procyclical fiscal policy at the aggregate level exacerbates the risk of belief-driven deflationary downturns. The model provides an argument in favor of coordinated, asymmetric fiscal stances as a way to prevent selffulfilling debt crises.
Subject: Expenditure, Fiscal policy, Fiscal stance, National accounts, Public debt, Return on investment
Keywords: Belief-Driven fluctuation, copyright page, debt level, economic activity, euro area, Fiscal stance, Global, government debt, monetary union, pooling of sovereign risk, Return on investment, risk pooling, risk premium, sovereign risk, Sovereign risk channel, stressed economy, transmission mechanism, WP, zero lower bound
Pages:
49
Volume:
2013
DOI:
Issue:
227
Series:
Working Paper No. 2013/227
Stock No:
WPIEA2013227
ISBN:
9781475513448
ISSN:
1018-5941
