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Tangos, Sambas or Belly Dancing? Or, do Spreads Dance to the Same Rhythm? Signaling Regime Sustainability in Argentina, Brazil and Turkey


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  • Santiago Herrera
  • Ferhan Salman


This paper examines the role of primary fiscal balances as a signaling device in a world in which investors are uncertain about the sovereign’s commitment to honor its obligations. Based on the Drudi-Prati model that rationalizes delayed stabilization and debt accumulation, we verify the existence of a rating (sovereign spreads) function that depends negatively (positively) on the debt ratio and negatively (positively) on the primary balance. This relationship, however, is non-monotonic and is conditioned on a threshold debt level. At low debt levels, the primary balance has an ambiguous relationship with sovereign spreads, but as debt increases, the primary balance’s effect on spreads is magnified. Beyond a given threshold, the committed sovereign has the incentive to tighten fiscal policy, while the weak government does not. Using data for Argentina, Brazil, and Turkey, for the period 1994-2007, we show that during their most recent crises, Brazil and Turkey can be characterized as dependable (in Drudi-Prati’s terminology), while Argentina’s incentives to use the primary balance in the late nineties were not as determinant. The explanatory power of the model improves by allowing heteroskedasticity in the shocks to each country and heterogeneity across countries in the coefficient estimates. Hence, though spreads react to debt levels and to primary balances in these countries, they do so with different intensity.

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Paper provided by Research and Monetary Policy Department, Central Bank of the Republic of Turkey in its series Working Papers with number 0807.

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Date of creation: 2008
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Handle: RePEc:tcb:wpaper:0807

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  1. S. Rao Aiyagari, 1988. "Economic fluctuations without shocks to fundamentals; or, does the stock market dance to its own music?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 8-24.
  2. Henning Bohn, 1998. "The Behavior Of U.S. Public Debt And Deficits," The Quarterly Journal of Economics, MIT Press, vol. 113(3), pages 949-963, August.
  3. Missale, Alessandro, 1997. " Managing the Public Debt: The Optimal Taxation Approach," Journal of Economic Surveys, Wiley Blackwell, vol. 11(3), pages 235-65, September.
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