Sovereign risk and belief-driven fluctuations in the euro area
Accepted version
Peer-reviewed
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Abstract
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 self-fulfilling debt crises. © 2013 International Monetary Fund.
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Keywords
Sovereign risk channel, Monetary union, Euro area, Zero lower bound, Risk premium, Pooling of sovereign risk
Journal Title
Journal of Monetary Economics
Conference Name
Journal ISSN
0304-3932
1873-1295
1873-1295
Volume Title
61
Publisher
Elsevier BV