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Fiscal Deficits, Public Debt, and Sovereign Bond Yields

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  • Manmohan S. Kumar
  • Emanuele Baldacci
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    Abstract

    The recent sharp increase in fiscal deficits and government debt in many countries raises questions regarding their impact on long-term sovereign bond yields. While economic theory suggests that this impact is likely to be adverse, empirical results have been less clear cut, have generally ignored nonlinear effects of deficits and debt through some other key determinants of yields, and have been mostly confined to advanced economies. This paper reexamines the impact of fiscal deficits and public debt on long-term interest rates during 1980 - 2008, taking into account a wide range of country-specific factors, for a panel of 31 advanced and emerging market economies. It finds that higher deficits and public debt lead to a significant increase in long-term interest rates, with the precise magnitude dependent on initial fiscal, institutional and other structural conditions, as well as spillovers from global financial markets. Taking into account these factors suggests that large fiscal deficits and public debts are likely to put substantial upward pressures on sovereign bond yields in many advanced economies over the medium term.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 10/184.

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    Length: 28
    Date of creation: 01 Aug 2010
    Date of revision:
    Handle: RePEc:imf:imfwpa:10/184

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    Keywords: Budget deficits; Public debt; Bonds; Interest rates; Fiscal policy; Developed countries; Emerging markets; Cross country analysis; Economic models; bond yields; fiscal balance; fiscal deficits; government bond; term bond; long-term bond yields; primary fiscal balance; government bond yields; fiscal variables; sovereign bond; debt service; financial market; global bond; financial markets; fiscal balance in percent; government bonds; fiscal conditions; bond markets; fiscal indicators; fiscal stance; fiscal consolidation; fiscal expansions; fiscal adjustment; sovereign bond markets; public bond; crowding out; fiscal discipline; fiscal balances; fiscal imbalances; public finances; bond yield curve; fiscal rules; financial systems; primary fiscal deficit; fiscal solvency; financial globalization; budget constraint; fiscal risks; fiscal frameworks; fiscal institutions; fiscal retrenchments; tax cuts; fiscal sustainability; fiscal adjustments; fiscal vulnerability; fiscal affairs department; domestic bond; stock market; fiscal problems; tax revenues; foreign capital; primary deficit; nominal interest rate; fiscal agencies; fiscal adjustment efforts; stock market volatility; increase in debt service; fiscal stability; fiscal developments; government bond markets; global bond markets; tax policy; aggregate demand; financial sector;

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    8. Manmohan S. Kumar & David Hauner, 2006. "Fiscal Policy and Interest Rates," IMF Working Papers 06/112, International Monetary Fund.
    9. Bernardin Akitoby & Thomas Stratmann, 2008. "Fiscal Policy and Financial Markets," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 118(533), pages 1971-1985, November.
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    Cited by:
    1. Agnello, Luca & Furceri, Davide & Sousa, Ricardo M., 2013. "How best to measure discretionary fiscal policy? Assessing its impact on private spending," Economic Modelling, Elsevier, Elsevier, vol. 34(C), pages 15-24.
    2. Beirne, John & Fratzscher, Marcel, 2013. "The pricing of sovereign risk and contagion during the European sovereign debt crisis," Journal of International Money and Finance, Elsevier, Elsevier, vol. 34(C), pages 60-82.
    3. Airaudo, Marco, 2012. "Endogenous Dollarization, Sovereign Risk Premia and the Taylor Principle," School of Economics Working Paper Series, LeBow College of Business, Drexel University 2012-11, LeBow College of Business, Drexel University.
    4. Grzegorz Poniatowski, 2014. "Common Currency and Determinants of Government Bond Risk Premiums," Central European Journal of Economic Modelling and Econometrics, CEJEME, CEJEME, vol. 6(2), pages 70-87, June.
    5. Jaramillo, Laura & Weber, Anke, 2013. "Bond yields in emerging economies: It matters what state you are in," Emerging Markets Review, Elsevier, Elsevier, vol. 17(C), pages 169-185.
    6. Serkan Arslanalp & Tigran Poghosyan, 2014. "Foreign Investor Flows and Sovereign Bond Yields in Advanced Economies," IMF Working Papers 14/27, International Monetary Fund.
    7. Thammarak Moenjak & Kengjai Watjanapukka & Oramone Chantapant & Teeravit Pobsukhirun, 2010. "New Globalization: Risks and Opportunities for Thailand in the Next Decade," Working Papers, Economic Research Department, Bank of Thailand 2010-04, Economic Research Department, Bank of Thailand.
    8. Guglielmo Maria Caporale & Alessandro Girardi, 2011. "Fiscal Spillovers in the Euro Area," CESifo Working Paper Series 3693, CESifo Group Munich.
    9. Salvatore Dell’Erba & Emanuele Baldacci & Tigran Poghosyan, 2013. "Spatial spillovers in emerging market spreads," Empirical Economics, Springer, Springer, vol. 45(2), pages 735-756, October.
    10. Bertrand Gruss & Jose L. Torres, 2012. "Macroeconomic and Welfare Costs of U.S. Fiscal Imbalances," IMF Working Papers 12/38, International Monetary Fund.
    11. Zlatuse Komarkova & Vilma Dingova & Lubos Komarek, 2013. "Fiscal sustainability and financial stability," Occasional Publications - Chapters in Edited Volumes, Czech National Bank, Research Department, in: CNB Financial Stability Report 2012/2013, chapter 0, pages 103-112 Czech National Bank, Research Department.
    12. Davide Furceri & Aleksandra Zdzienicka, 2013. "The Euro Area Crisis," IMF Working Papers 13/198, International Monetary Fund.
    13. Salvatore Dell'Erba & Sergio Sola, 2013. "Does Fiscal Policy Affect Interest Rates? Evidence from a Factor-Augmented Panel," IMF Working Papers 13/159, International Monetary Fund.

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