NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

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NBER Working Papers and Publications

September 2003Tough Policies, Incredible Policies?
with Andres Velasco: w9932
We revisit the question of what determines the credibility of macroeconomic policies here, of promises to repay public debt. Almost all thinking on the issue has focused on governments' strategic decision to default (or erode the value of outstanding debt via inflation/devaluation). But sometimes governments default not because they want to, but because they cannot avoid it: adverse shocks leave them no option. We build a model in which default/devaluation can occur deliberately (for strategic reasons) or unavoidably. If such unavoidable fiscal crises a) have pecuniary costs and b) occur with possible probability, much conventional wisdom on the determinantes of credibility need no longer hold. For instance, appointing a conservative policymaker or denominating public debt in foreign cur...
 
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