A Political Economy of Fiscal Space: Political Structures, Bond Markets, and Monetary Accommodation of Government Spending Potential at Municipal, National, and International Levels

Abstract

In times of economic crisis, academics, policy-makers, and pundits often debate how much government debt is too much. This paper argues that discourses about fiscal space should consider several political economic factors beyond the ratio of fiscal deficits and debt to GDP when determining the sustainability of any economy’s fiscal deficit. These include political constraints on both government spending and taxation, financial and monetary dynamics in bond markets for sovereign debt, and the relative hierarchy of governments attempting to issue sovereign debt. While the federal governments of the US and Germany may easily issue and sell debt in private markets, smaller economies are more vulnerable to demand fluctuations, and will benefit from explicit commitments by monetary authorities to resume their historic roles as governments’ banks, especially during crises. By highlighting present political constraints, monetary structures, and market factors that may inhibit governments’ successful placement of bonds, it deepens present debate about the potential feasibility of functional finance to facilitate fiscal activity, even in unprecedented times.