Sovereign ratings,macroeconomic dynamics,and fiscal policy. Interactions within a stock flow consistent framework

Operating in the context of deregulated financial markets, credit rating agencies do not only ‘provide an opinion’, but also affect macroeconomic dynamics. By utilizing a two‐country stock flow consistent model that provides a representation of the Eurozone, the paper connects the movements of sovereign ratings with the dynamics of the financial market and the constraints on fiscal policy. With endogenous fiscal expenditure and an endogenous credit rating mechanism the model shows how following a recessionary shock, a rating downgrade can influence the financial constraints that surround a government, pushing it toward fiscal austerity and thereby deepening the already ongoing recession.