Philipp Engler, Christoph Große Steffen
The European sovereign debt crisis has highlighted the role of spillovers from sovereign default risk to financial intermediation in shaping macroeconomic dynamics. We propose a quantitative model which captures this feedback mechanism by allowing for explicit default on public debt and occasionally binding collateral constraints on the interbank market in a general equilibrium setting. A link to the real economy is established by a working capital assumption. It emerges a role of government debt policy for the provision of liquidity which leads to non-Ricardian effects of public debt which can be either positive or negative, conditional on sovereign default risk. We replicate central features of the European sovereign debt crisis through numerical simulations: hikes in sovereign risk impede the financial intermediation process, risk premia are countercyclical, and a home bias in government debt allows higher average debt levels. The preliminary findings of the paper indicatethat under special conditions fiscal consolidation may become expansionary.
JEL-Classification: E44;H63
Keywords: Optimal sovereign default, financial intermediation, liquidity, non-Ricardian effects, occasionally binding constraints
DIW-Link
Array