Cost of borrowing shocks and fiscal adjustment

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. (2009) to identify structural cost of borrowing shocks. Our baseline estimation shows that a one percentage point rise in the cost of borrowing leads to a cumulative improvement of the primary balance-to-GDP ratio of approximately 1.9 percentage points over 10 years, with the …scal response becoming signi…cantly evident only two years after the shock. We also …nd that the bulk of …scal adjustment takes place via a rise in government revenue rather than a cut in primary expenditure. The size of the total …scal adjustment, however, is insu¢ cient to avoid the gross government debt-to-GDP ratio from rising as a consequence of the shock. Sub-dividing our sample, we also …nd that for countries participating in Economic and Monetary Union (EMU) the primary balance response to a cost of borrowing shock was stronger in the period after 1992 (the year in which the Maastricht Treaty was signed) than prior to 1992. Terms of use: Documents in EconStor mayKeywords: Fiscal policy, Long-term interest rates, Vector-autoregressive models, Sign restrictions JEL classi…cations: C33, E43, E62, H60 1 Non-technical summaryDuring the ongoing European sovereign debt crisis, sharp rises in yields on government bonds have been met with promises from governments to accelerate and expand their …scal consolidation plans. To the extent these promises are acted upon, this behaviour can be interpreted as a form of market imposed …scal discipline. Against this background, this paper examines empirically the proposition that governments systematically respond to adverse shocks in their market borrowing rates by improving their …scal positions.Based on a vector autoregressive (VAR) model with a panel of 14 European countries and annual data from 1970 to 2011, it …nds a statistically signi…cant …scal policy response to exogenous changes in the cost of borrowing. A one percentage point rise in the cost of borrowing leads to a cumulative increase in the primary balance-to-GDP ratio of 1.9 percentage points after 10 years. However, the debt-to-GDP ratio is 1.0 percentage points higher 10 years after the shock, i.e. the budgetary response is insu¢ cient to compensate for the automatic debt-increasing e¤ect of higher borrowing costs. The impulse responses reveal that the …scal response is not immediate, with a signi…cant consolidation appearing only two years after the shock. A decomposition of the primary budget balance into its revenue and expenditure components shows that almost all the adju...

Addressing the Safety Trilemma: A Safe Sovereign Asset for the Eurozone

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Euro Area Periphery Countries’ Fiscal Policy and Monetary Policy Surprises

“…However, for some countries the attempt to maintain fiscal sustainability appears to have weakened after 2008. Theofilakou and Stournaras (2012), Legrenzi andMilas (2013), andde Groot et al (2015) show that euro area governments' fiscal positions react to changes in the cost of borrowing. The debt stabilisation effort is more pronounced in low debt countries, whereas highly indebted countries seem to undertake less effort to mitigate the burden of higher borrowing cost (Theofilakou and Stournaras, 2012).…”

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