Template-Type: ReDIF-Paper 1.0 Series: Tinbergen Institute Discussion Papers Creation-Date: 2011-04-12 Number: 11-064/2/ DSF20 Author-Name: Andreas Schabert Author-Email: email@example.com Author-Workplace-Name: TU Dortmund University , University of Amsterdam Author-Name: Sweder J.G. van Wijnbergen Author-Email: firstname.lastname@example.org Author-Workplace-Name: University of Amsterdam Title: Sovereign Default and the Stability of Inflation Targeting Regimes Abstract: This discussion paper resulted in a publication in the 'IMF Economic Review', 2014, 62(2), 261-287.
We analyse the impact of interactions between monetary and fiscal policy on macroeconomic stability. We find that in the presence of sovereign default beliefs a monetary policy, which aims to stabilize inflation through an active interest rate policy, will destabilize the economy if the feedback from debt surprises back to the primary surplus is too weak. This result, which relies on endogenous changes in the default premium, is at odds with the results in an environment without default risk, where an active monetarypolicy guarantees macroeconomic stability. The results are highly relevant for the design of fiscal and monetary policy in emerging markets where sovereign credibility is not well established. Recent debt developments in Western Europe and in the US suggest these results might become relevant for more mature financial markets too. Classification-JEL: E52, E63, F41 Keywords: Inflation targeting, fiscal-monetary policy interactions, sovereign default risk, foreign debt File-Url: http://papers.tinbergen.nl/11064.pdf File-Format: application/pdf File-Size: 282150 bytes Handle: RePEc:tin:wpaper:20110064