Fiscal Adjustment and the Costs of Public Debt Service: Evidence from OECD Countries
AbstractWe use a panel of 21 OECD countries from 1970 to 2009 to investigate the effects of different fiscal adjustment strategies on long-term interest rates – a key fiscal indicator reflecting the costs of government debt service. A government confronted with high deficits and rising debt will sooner or later need to enact fiscal adjustments in order to avoid solvency problems. Over the last four decades, such measures taken by governments in OECD countries have varied in duration, size, composition and in their success to re-establish fiscal sustainability. Controlling for various economic, fiscal and political factors, we find that the size and the composition of a fiscal adjustment significantly affect interest rates as well as yield spreads. Adjustments that are relatively large and those that primarily depend on expenditure cuts lead to substantially lower long-term interest rates. However, periods of fiscal adjustments do not generally have an influence on interest rates, even if they were successful and led to lower deficits and debt levels. Instead, financial markets only seem to value strict and decisive measures – a clear sign that the government’s pledge to cut the deficit is credible.
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Bibliographic InfoPaper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3297.
Date of creation: 2010
Date of revision:
fiscal adjustment; consolidation policy; government debt; deficit; interest rates;
Other versions of this item:
- Christoph A. Schaltegger & Martin Weder, 2010. "Fiscal Adjustment and the Costs of Public Debt Service: Evidence from OECD Countries," CREMA Working Paper Series 2010-08, Center for Research in Economics, Management and the Arts (CREMA).
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- H00 - Public Economics - - General - - - General
- H60 - Public Economics - - National Budget, Deficit, and Debt - - - General
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