Fiscal commitment and sovereign default risk

This paper studies the interaction between fiscal commitment and sovereign default risk in a model with optimal taxation government spending. A time-inconsistency problem arises our framework as cannot credibly commit to its future tax policies. As result, it chooses suboptimally low adjustments defaults too frequently. Introducing device policies can mitigate this improve government's borrowing opportunities. However, such also entails loss of contingency that might be costly. Our quantitative analysis shows committing an inflexible plan is counterproductive: lack hurts debt sustainability reduces welfare. In contrast, flexible contingent on economic conditions by 53.3% result significant welfare gain.