Fiscal Austerity and the Informativeness of Credit Ratings

This paper studies the signaling role of fiscal austerity. I construct a model where countries have different ability to commit to raise taxes in the future, which affects their probability to repay their debts. The more able type can reduce debt more than the other type is willing to, thereby revealing its type, at the expense of reducing consumption today. How this trade-off resolves depends on the value of pooling. I use a measure of the credit ratings informativeness to proxy for the information at the pool and confirm that low informativeness is associated with a higher austerity due to the signaling motive.