Fiscal credibility has been an important issue in previous chapters. Credibility refers to the private sector's perception that the government will follow through on its policy announcements. We have seen so far that this perception is important from the perspective of the government's actual and prospective creditors as well as from that of workers.

Credibility in the eyes of prospective creditors is of vital importance to the government in a variety of ways. We have seen that it plays the central role in determining the solvency of the public sector and thus its ability to borrow. Creditors will not lend to the government unless they perceive that it has a credible plan to service its outstanding debt on market terms in the future. Moreover, as we saw in Chapter 8, when creditors' perception of the government's ability to pay falls very far short of the outstanding stock of debt, a debt “overhang” emerges that can have serious macroeconomic consequences.

Fiscal credibility in the eyes of creditors also matters when the government is trying to change how it finances a fiscal deficit. If the government has been servicing its debt in part by relying on the seignorage revenue associated with a high rate of inflation, and the high economic costs of doing so cause it to attempt to stabilize, one of the most important determinants of its success in doing so is its fiscal credibility.