Sovereign Risk and Belief-Driven Fluctuations in the Euro Area

By Giancarlo Corsetti, Keith Kuester, Andre Meier, Gernot J. Mueller

November 6, 2013

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Giancarlo Corsetti, Keith Kuester, Andre Meier, and Gernot J. Mueller Sovereign Risk and Belief-Driven Fluctuations in the Euro Area, (USA: International Monetary Fund, 2013) accessed March 6, 2025

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

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 selffulfilling debt crises.

Subject: Expenditure, Fiscal policy, Fiscal stance, National accounts, Public debt, Return on investment

Keywords: Belief-Driven fluctuation, Copyright page, Debt level, Economic activity, Euro area, Fiscal stance, Global, Government debt, Monetary union, Pooling of sovereign risk, Return on investment, Risk pooling, Risk premium, Sovereign risk, Sovereign risk channel, Stressed economy, Transmission mechanism, WP, Zero lower bound

Publication Details

Pages:

49
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2013/227
Stock No:

WPIEA2013227
ISBN:

9781475513448
ISSN:

1018-5941

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