Sovereign default and the sustainability risk premium effect |
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| Institution: | 1. International Monetary Fund, 700 19th Street, NW Washington, DC, 20431, US and Department of Economics and Management, University of Padua, Via del Santo 33, 35123 Padova, Italy;2. Banca d’Italia, Via Nazionale 91, 00184 Rome, Italy;1. University of Minnesota, USA;2. Chinese University of Hong Kong, Hong Kong;3. City University of Hong Kong, Hong Kong;1. Department of Economics, University of Oregon, Eugene, OR 97403-1285, United States;2. Department of Economics, Purdue University, West Lafayette, IN 47907-2056, United States;1. The Business School, Bangor University, Bangor LL57 2DG, UK;2. Institut de Recherches Economiques et Social, Université Catholique de Louvain, Louvain, Belgium |
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| Abstract: | We analyze the joint determination of interest rate risk and debt sustainability for governments with fiscal imbalances. Because higher interest rates imply increased debt services, they worsen the government's financial situation and increase the probability of sovereign default. Thus, higher interest rates eventually lead to a decrease in the real demand for government bonds, which imposes an additional constraint on government debt sustainability. |
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