Fiscal Consolidation and Sovereign Risk in the Euro-zone Periphery

Sovereign and private sector default probabilities are introduced in a monetary model to evaluate whether the consideration of a sovereign risk channel can a¤ect the size and sign of fiscal multipliers, an hypothesis recently appeared in the literature. The model is estimated using data of EZ peripheral countries. From posterior estimates and simulations we show that i) the relation between fundamentals, sovereign risk and interest rate spreads is weak; ii) in the short term, the risk channel operates in a pro- cyclical direction, amplifying the e¤ects of …scal contractions; iii) the consideration of a liquidity trap does not reverse this result.