Title: Imperfect financial markets and the cyclicality of social spending
Authors: Wojtek Paczos - Cardiff University (United Kingdom) [presenting]
Maren Froemel - London Business School (United Kingdom)
Abstract: The link between default risk and the cyclicality of redistribution is explored. Empirically, we establish a stylized fact, that countries with higher sovereign risk have more procyclical fiscal policy. We build a small open economy model with heteregenous households, government consumption, social transfers, and endogenous default risk to rationalize this fact. With low default risk social spending is countercyclical, inequality is procyclical, and external debt is used to smooth distortionary taxation. With high default risk, social spending is procyclical and accounts for most of fiscal adjustment when risk premia are positive, because taxation becomes costly for the government.