Eduardo Amaral · 2021 · Ph.D. thesis, Chapter 2 · PUC-Rio
What if the government can default on monetary policy assets? This paper studies how sovereign default risk transmits to monetary policy depending on the policy instrument’s credit risk. We lay out a two-agent New-Keynesian (TANK) model with endogenous fiscal limits and then calibrate it to a large emerging economy, Brazil. We find that endogenous expectations of a severe recession in case of default push inflation, real, and nominal policy rates higher in the equilibrium distribution of the model. By ignoring risk in the policy asset, the central bank reinforces that unpleasant coincidence. From a policy perspective, these results raise concerns on the evaluation of monetary policy stance in default-risky economies, while arguably solve a long-standing conundrum of the Brazilian economy.
Amaral, Eduardo G. C. (2021). “An Unpleasant Coincidence for Monetary Policy: Risky Assets and Fiscal Limits.” Chapter 2 of Essays in Monetary Policy with Risky Assets, Ph.D. thesis, Pontifical Catholic University of Rio de Janeiro (PUC-Rio).
@unpublished{Amaral2021UnpleasantCoincidence,
author = {Amaral, Eduardo G. C.},
title = {An Unpleasant Coincidence for Monetary Policy: Risky Assets and Fiscal Limits},
year = {2021},
note = {Chapter 2 of Essays in Monetary Policy with Risky Assets, Ph.D. thesis, PUC-Rio},
url = {https://github.com/edugca/PhD_Thesis/raw/main/Ch%202%20%E2%80%93%20An%20Unpleasant%20Coincidence%20for%20Monetary%20Policy.pdf}
}