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Public deficits and borrowing costs: the missing half of market discipline

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  • Heinemann, Friedrich
  • Winschel, Viktor

Abstract

EMU driven interest rate convergence has led to a significant reduction of borrowing costs for some European governments in the second half of the nineties. The paper deals with the possible consequences for deficit behaviour. Although the impact of interest rates on deficits is a crucial element of the market discipline hypothesis it has widely been neglected in the literature. In the theoretical part, a standard political economic model of budgetary policy (Hettich-Winer) is adapted. It turns out that borrowing costs, measured as the interest-growth-differential, and the level of public debt should be important determinants for public deficits. The econometric part tests these predictions for a panel of OECD countries. The results indicate that there is indeed a significant impact of borrowing costs on the primary surplus. This impact is characterised by a robust asymmetry: Reactions in times of increasing borrowing costs are more pronounced than in times of relaxing conditions. --

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Bibliographic Info

Paper provided by ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research in its series ZEW Discussion Papers with number 01-16.

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Date of creation: 2001
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Handle: RePEc:zbw:zewdip:5371

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Keywords: market discipline; borrowing costs; EMU; public debt; government deficits;

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References

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  1. Metcalf, Gilbert E., 1993. "Federal taxation and the supply of state debt," Journal of Public Economics, Elsevier, Elsevier, vol. 51(3), pages 269-285, July.
  2. Favero, Carlo A & Giavazzi, Francesco & Spaventa, Luigi, 1996. "High Yields: The Spread on German Interest Rates," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1330, C.E.P.R. Discussion Papers.
  3. Hettich, W. & Winter, S.L., 1993. "The Political Economy of Taxation," Papers, Carleton - Business Administration 93-2, Carleton - Business Administration.
  4. Eichengreen, Barry & Bayoumi, Tamim, 1994. "The political economy of fiscal restrictions: Implications for Europe from the United States," European Economic Review, Elsevier, Elsevier, vol. 38(3-4), pages 783-791, April.
  5. Giovannini, Alberto & Piga, Gustavo, 1992. "Understanding the High Interest Rates on Italian Government Securities," CEPR Discussion Papers, C.E.P.R. Discussion Papers 720, C.E.P.R. Discussion Papers.
  6. Bayoumi, Tamim & Goldstein, Morris & Woglom, Geoffrey, 1995. "Do Credit Markets Discipline Sovereign Borrowers? Evidence from US States," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1088, C.E.P.R. Discussion Papers.
  7. Hettich, Walter & Winer, Stanley, 1984. "A positive model of tax structure," Journal of Public Economics, Elsevier, Elsevier, vol. 24(1), pages 67-87, June.
  8. Hettich, Walter & Winer, Stanley L, 1988. "Economic and Political Foundations of Tax Structure," American Economic Review, American Economic Association, American Economic Association, vol. 78(4), pages 701-12, September.
  9. Jacob A. Frenkel & Morris Goldstein, 1991. "Monetary Policy in an Emerging European Economic and Monetary Union: Key Issues," IMF Staff Papers, Palgrave Macmillan, vol. 38(2), pages 356-373, June.
  10. Alberto Alesina & Roberto Perotti, 1995. "The Political Economy of Budget Deficits," IMF Staff Papers, Palgrave Macmillan, vol. 42(1), pages 1-31, March.
  11. Francesco P. Mongelli, 1997. "Effects of the European Economic and Monetary Union (EMU)on Taxation and Interest Spending of National Governments," IMF Working Papers 97/93, International Monetary Fund.
  12. Timothy D. Lane, 1993. "Market Discipline," IMF Staff Papers, Palgrave Macmillan, vol. 40(1), pages 53-88, March.
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Cited by:
  1. Friedrich Heinemann, 2006. "Factor mobility, government debt and the decline in public investment," International Economics and Economic Policy, Springer, vol. 3(1), pages 11-26, April.
  2. Philipp Paulus, 2006. "Brüssel, Frankfurt oder Basel - Wo muss das Problem steigender Staatsschulden in der Europäischen Währungsunion gelöst werden?," Otto-Wolff-Institut Discussion Paper Series, Otto-Wolff-Institut für Wirtschaftsordnung, Köln, Deutschland 01/2006, Otto-Wolff-Institut für Wirtschaftsordnung, Köln, Deutschland.
  3. Bernoth, Kerstin & von Hagen, Jürgen & Schuknecht, Ludger, 2012. "Sovereign risk premiums in the European government bond market," Journal of International Money and Finance, Elsevier, Elsevier, vol. 31(5), pages 975-995.
  4. Philipp Paulus, 2004. "The fiscal stability impact of monetary unions - looking beneath the Stability Pact debate," Otto-Wolff-Institut Discussion Paper Series, Otto-Wolff-Institut für Wirtschaftsordnung, Köln, Deutschland 05/2004, Otto-Wolff-Institut für Wirtschaftsordnung, Köln, Deutschland.

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