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Fiscal policy and interest rates: the role of financial and economic integration

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Author Info
Peter Claeys () (Faculty of Economics, University of Barcelona)
Rosina Moreno () (Faculty of Economics, University of Barcelona)
Jordi Suriñach () (Faculty of Economics, University of Barcelona)

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Abstract

It is commonly believed that a fiscal expansion raises interest rates. However, these crowding out effects of deficits have been found to be small or non-existent. One explanation is that financial integration offsets interest rate differentials on globalised bond markets. This paper measures the degree of integration of government bond markets, using spatial modelling techniques to take this spillover on financial markets into account. Our main finding is that the crowding out effect on domestic interest rates is significant, but is reduced by spillover across borders. This spillover is important in major crises or in periods of coordinated policy actions. This result is generally robust to various measures of cross-country linkages. We find spillover to be much stronger among EU countries.

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Paper provided by University of Barcelona, Research Institute of Applied Economics in its series IREA Working Papers with number 200810.

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Length: 29 pages
Date of creation: Sep 2008
Date of revision: Sep 2008
Handle: RePEc:ira:wpaper:200810

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Keywords: fiscal policy; spillover; interest rates; crowding out; spatial models.;

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