DG ECFIN: Expected sovereign defaults and fiscal consolidations

11 April 2013

This paper by Werner Roeger and Jan in 't Veld uses a two region DSGE model for the euro area (periphery vs core), to analyse the costs of higher sovereign risk premia, the so-called 'sovereign risk channel'.

The authors highlight the importance of valuation effects of sovereign bonds in bank balance sheets for the transmission of sovereign default expectations to the private sector.

While at the current juncture the fiscal multiplier is larger in the EA periphery, the authors show that for highly indebted countries in the EA no fiscal consolidation could have more detrimental effects if it leads to expectations of sovereign default. In their view, these results provide useful additional information for the debate on fiscal austerity which focusses mainly on the size of the multiplier.

Summary for non-specialists

Full paper

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