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      Fiscal Rules and Sovereign Default
      27 Jun 2016Working Paper Summaries

      Fiscal Rules and Sovereign Default

      by Laura Alfaro and Fabio Kanczuk
      As they catch up to developed ones, emerging countries tend to overborrow and often default on their debt. This study by Laura Alfaro and Fabio Kanczuk analyzes the welfare gains from alternative fiscal rules, finding the gains economically important. What is more, a simple, easily contractible threshold rule can generate gains virtually as high as the optimal rule.
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      Author Abstract

      We provide a quantitative analysis of fiscal rules in a standard model of sovereign debt accumulation and default modified to incorporate quasi-hyperbolic preferences. For reasons of political economy or aggregation of citizens’ preferences, government preferences are present biased, resulting in an over accumulation of debt. Calibrating this parameter with values in the literature, the model can reproduce debt levels and frequency of default typical of emerging markets even if the household impatience parameter is calibrated to local interest rates. A quantitative exercise calibrated to Brazil finds welfare gains of the optimal fiscal policy to be economically substantial, and the optimal rule to not entail a countercyclical fiscal policy. A simple debt rule that limits the maximum amount of debt is analyzed and compared to a simple deficit rule that limits the maximum amount of deficit per period. Whereas the deficit rule does not perform well, the debt rule yields welfare gains virtually equal to the optimal rule.

      Paper Information

      • Full Working Paper Text
      • Working Paper Publication Date: June 2016
      • HBS Working Paper Number: 16-134
      • Faculty Unit(s): Business, Government and International Economy
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      Laura Alfaro
      Laura Alfaro
      Warren Alpert Professor of Business Administration
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