Year of Graduation
Macroeconomic Policy under Sovereign Default Risk
Recent empirical literature on expansionary fiscal contractions found out that under certain circumstances an increase in taxes may cause an increase in private consumption. One of such circumstances is high level of public debt. The reversed effect of fiscal policy on private consumption is based on increase of expected income in the future. In case a budget contraction is crucial to avoid sovereign default and corresponding costs for economy, it has positive effect on private consumption.In the paper two period model is developed. The model allows to show a non-linear relation between private consumption and income tax rate. In case an increase in tax rate makes full debt repayment possible, it causes an increase in private consumption.