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Sovereign risk and belief-driven fluctuations in the euro area

Thursday 2nd May 2024
Journal of Monetary Economics
Corsetti, G., Kuester, K., Meier, A. and Müller, G. J.
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 self-fulfilling debt crises.
Keywords
Sovereign risk channel
monetary union
euro area
zero lower bound
risk premium
pooling of sovereign risk
E62
F41
F42
Themes
1
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