Fiscal Policy, Sovereign Default, and Bailouts

Arbeitspapier

This paper examines fiscal policy without commitment and the effects of conditional bailout loans. The government relies on distortionary taxation and decides between full debt repayment and costly default. It tends to overborrow due to myopia, which induces default to be a relevant policy option and provides a rationale to constrain sovereign borrowing. We consider a lump-sum financed fund that offers loans at a favorable price and conditional upon minimum primary surpluses. While the government prefers defaulting in the most adverse states, we find that it is willing to accept conditional loans in close-to-default states. These bailouts can lead to an increase in the mean debt price and a lower default probability that are associated with enhanced household welfare. Yet, these outcomes can be reversed when bailouts are too generous, while public debt never decreases in the long-run when bailout loans are available.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: IZA Discussion Papers ; No. 7805

Classification and Topics

• Classification: Wirtschaft ; Business Fluctuations; Cycles ; Taxation and Subsidies: Efficiency; Optimal Taxation ; National Debt; Debt Management; Sovereign Debt
• Subject: discretionary fiscal policy ; overborrowing ; sovereign default ; bailout loans ; conditionality

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Juessen, Falko ; Schabert, Andreas
• Event: Veröffentlichung
• (who): Institute for the Study of Labor (IZA)
• (where): Bonn
• (when): 2013

Further information

• Handle: http://hdl.handle.net/10419/89823
• Last update: 10.03.2025, 11:44 AM CET