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Silvia Ardagna

29 September 2004
WORKING PAPER SERIES - No. 390
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Abstract
Using a panel of OECD countries from 1960 to 2002, this paper shows that financial markets value fiscal discipline. Interest rates, particularly those of long-term government bonds, decrease when countries' fiscal position improves and increase around periods of budget deteriorations. Stock market prices surge around times of substantial fiscal tightening and plunge in periods of very loose fiscal policy. In addition, the paper shows that results depend on countries' initial fiscal conditions and on the type of fiscal consolidations. Fiscal adjustments that occur in country-years with high levels of government defcit, that are implemented by cutting government spending, and that generate a permanent and substantial decrease in government debt are associated with larger reductions in interest rates and increases in stock market prices.
JEL Code
E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
H62 : Public Economics→National Budget, Deficit, and Debt→Deficit, Surplus
30 November 2004
WORKING PAPER SERIES - No. 411
Details
Abstract
We use a panel of 16 OECD countries over several decades to investigate the effects of government debts and deficits on long-term interest rates. In simple static specifications, a one-percentage-point increase in the primary deficit relative to GDP increases contemporaneous long-term interest rates by about 10 basis points. In a vector autoregression (VAR), the same shock leads to a cumulative increase of almost 150 basis points after 10 years. The effect of debt on interest rates is non-linear: only for countries with above-average levels of debt does an increase in debt affect the interest rate. World fiscal policy is also important: an increase in total OECD-government borrowing increases each country's interest rates. However, domestic fiscal policy continues to affect domestic interest rates even after controlling for worldwide debts and deficits.
JEL Code
E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
H62 : Public Economics→National Budget, Deficit, and Debt→Deficit, Surplus