Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/86735 
Year of Publication: 
2011
Series/Report no.: 
Tinbergen Institute Discussion Paper No. 11-064/2/ DSF20
Publisher: 
Tinbergen Institute, Amsterdam and Rotterdam
Abstract: 
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.
Subjects: 
Inflation targeting
fiscal-monetary policy interactions
sovereign default risk
foreign debt
JEL: 
E52
E63
F41
Document Type: 
Working Paper

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