Working Paper

Seigniorage and Sovereign Default: The Response of Emerging Markets to COVID-19

Abstract: Monetary policy affects the tradeoffs faced by governments in sovereign default models. In the absence of lump-sum taxation, governments rely on both disortionary taxes and seigniorage to finance expenditure. Furthermore, monetary policy adds a time-consistency problem in debt choice, which may mitigate or exacerbate the incentives to accumulate debt. A deterioration of the terms-of-trade leads to an increase in sovereign-default risk and inflation, and a reduction in growth, which are consistent with the empirical evidence for emerging economies. An unanticipated shock resembling the COVID-19 pandemic generates a significant currency depreciation, increased inflation, and distress in government finances.

Keywords: Crises; Default; Sovereign Debt; Exchange Rate; Country Risk; Inflation; Seigniorage; Fiscal Policy; Emerging Markets; Time-consistency; COVID-19;

JEL Classification: E52; E62; F34; F41; G15;

https://doi.org/10.20955/wp.2020.017

Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2020-07-10

Number: 2020-017

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