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Fiscal Policy and the Term Structure: Evidence from the Case of Italy in the EMS and the EMU Periods

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Author Info
Favero, Carlo A
Giglio, Stefano W

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Abstract

We study the relationship between the term structure of interest rates and fiscal policy by considering the Italian case. Empirical analysis has been so far rather inconclusive on this important topic. We abscribe such evidence to three problems: identification, regime-switching and maturity effects. All these aspects are particularly relevant to the Italian case. We propose a parsimonious model with three factors to represent the whole yield curve, and we consider yield differentials between Italian and German Government bonds. To take into account the possibility of regime-switching, we explicitly include a hidden two-state Markov chain that represents market expectations. The model is estimated using Bayesian econometric techniques. We find that government debt and its evolution significantly influence the yield of government bonds, that such effects are maturity dependent and regime-dependent. Hence when investigating the effect of fiscal policy on the term-structure it is of crucial importance to allow for multiple regimes in the estimation.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5793.

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Date of creation: Aug 2006
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Handle: RePEc:cpr:ceprdp:5793

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Related research
Keywords: Bayesian estimation; fiscal policy; regime switching; term structure;

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Find related papers by JEL classification:
E0 - Macroeconomics and Monetary Economics - - General
G0 - Financial Economics - - General

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  18. Francis X. Diebold & Glenn D. Rudebusch & S. Boragan Aruoba, 2004. "The Macroeconomy and the Yield Curve: A Dynamic Latent Factor Approach," NBER Working Papers 10616, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  19. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December. [Downloadable!] (restricted)
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