Managing Default Risk
Revised version, March 2019
BIS Working Papers
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No 467
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08 October 2014
High sovereign debt in advanced economies has recently revived the debate about the role of coordination problems and self-fulfilling beliefs as drivers of sovereign default risk. I show how default risk can be decomposed in a solvency-risk component and a coordination-risk component. I then study how fiscal policy can be effective in managing the risk of coordination and I characterise how the shape of the optimal policy is affected by the presence of this risk: making the deficit contingent on interest rate movements is more effective in managing default risk than using non-contingent fiscal targets.
JEL classification: D82, D84, E62
Keywords: Default risk, fiscal policy, coordination, global games