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Working Paper
Soverign risk and the effects of fiscal retrenchment in deep recessions
The authors analyze the effects of government spending cuts on economic activity in an environment of severe fiscal strain, as reflected by a sizeable risk premium on government debt. Specifically, they consider a "sovereign risk channel," through which sovereign default risk spills over to the rest of the economy, raising funding costs in the private sector. The authors' analysis is based on a variant of the model suggested by Crdia and Woodford (2009). It allows for costly financial intermediation and inter-household borrowing and lending in equilibrium, but maintains the tractability of ...