Title: Sovereign Debt Constrained Economies and The Fiscal Trap
The aim of the research is to explore public debt deleveraging in a standard New-Keynesian sticky-price model where the fiscal policy is constrained by an upper limit borrowing That is the lower between two different bounds: the Natural Debt Limit (NDL) and an exogenous limit. The exogenous limit is the amount of public debt That investors perceived as safe. If the amount of debt perceived as safe is lower than the NDL, the fiscal authority is forced to deleverage by moving government spending or taxes. On the one hand, public debt deleveraging FINANCED by cutting spending has a depressive effect on demand but does not involve a long-lasting recession. On the other hand, deleveraging by labor taxes Generates a contraction in output such That the natural upper bound on public debt (the NDL) falls forcing further Top deleveragings. This induces a self-defeating cycle of fiscal reduction and economic contraction: in Fiscal Trap. Once the economy is caught in the trap the only way to escape it is an expansionary monetary policy.