Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/243195 
Year of Publication: 
2021
Series/Report no.: 
DIW Discussion Papers No. 1966
Publisher: 
Deutsches Institut für Wirtschaftsforschung (DIW), Berlin
Abstract: 
This paper examines the role of sovereign default beliefs for macroeconomic fluctuations and stabilization policy in a small open economy where fiscal solvency is a critical problem. We set up and estimate a DSGE model on Turkish data and show that accounting for sovereign risk significantly improves the fit of the model through an endogenous amplification between default beliefs, exchange rate and inflation movements. We then use the estimated model to study the implications of sovereign risk for stability, fiscal and monetary policy, and their interaction. We find that a relatively strong fiscal feedback from deficits to taxes, some exchange rate targeting, or a monetary response to default premia are more effective and efficient stabilization tools than hawkish inflation targeting.
Subjects: 
Small open economies
Sovereign risk
Monetary policy
Exchange rates
Business cycles
DSGE models
JEL: 
E58
E63
F41
Document Type: 
Working Paper

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