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 deficit, 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.
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Paper provided by European Central Bank in its series Working Paper Series with number
390.
Find related papers by JEL classification: 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
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Robert J. Barro & Xavier Sala-i-Martin, 1991.
"World Real Interest Rates,"
NBER Working Papers
3317, National Bureau of Economic Research, Inc.
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