Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/322911 
Year of Publication: 
2014
Series/Report no.: 
Discussion Papers Series No. 14-01
Publisher: 
Utrecht University, Utrecht School of Economics, Tjalling C. Koopmans Research Institute, Utrecht
Abstract: 
Keynesian theory predicts output responses upon a fiscal expansion in a small open economy to be larger under fixed than floating exchange rates. We analyse the effects of fiscal expansions using a New Keynesian model and find that the reverse holds in the presence of sovereign default risk. By raising sovereign risk, a fiscal expansion worsens private credit conditions and reduces consumption; these adverse effects are offset by an exchange rate depreciation and a rise in exports under a float, yet not under a peg. We find that output responses can even be negative when exchange rates are held fixed, suggesting the possibility of expansionary fiscal consolidations.
Subjects: 
Fiscal policy
government spending
exchange rate regime
sovereign risk
New Keynesian model
expansionary fiscal consolidation
Document Type: 
Working Paper

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