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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. Alberto Alesina & Roberto Perotti, 1995. "The Political Economy of Budget Deficits," IMF Staff Papers, Palgrave Macmillan, vol. 42(1), pages 1-31, March.
  2. Gilbert Metcalf, 1990. "Federal Taxation and the Supply of State Debt," NBER Working Papers 3255, National Bureau of Economic Research, Inc.
  3. Giovannini, Alberto & Piga, Gustavo, 1992. "Understanding the High Interest Rates on Italian Government Securities," CEPR Discussion Papers 720, C.E.P.R. Discussion Papers.
  4. Favero, Carlo A & Giavazzi, Francesco & Spaventa, Luigi, 1997. "High Yields: The Spread on German Interest Rates," Economic Journal, Royal Economic Society, vol. 107(443), pages 956-85, July.
  5. Barry Eichengreen and Tamim Bayoumi., 1993. "The Political Economy of Fiscal Restrictions: Implications for Europe from the United States," Center for International and Development Economics Research (CIDER) Working Papers C93-020, University of California at Berkeley.
  6. 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.
  7. Timothy D. Lane, 1993. "Market Discipline," IMF Staff Papers, Palgrave Macmillan, vol. 40(1), pages 53-88, March.
  8. Hettich, W. & Winter, S.L., 1993. "The Political Economy of Taxation," Papers 93-2, Carleton - Business Administration.
  9. Hettich, Walter & Winer, Stanley, 1984. "A positive model of tax structure," Journal of Public Economics, Elsevier, vol. 24(1), pages 67-87, June.
  10. 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.
  11. Bayoumi, Tamim & Goldstein, Morris & Woglom, Geoffrey, 1995. "Do Credit Markets Discipline Sovereign Borrowers? Evidence from US States," CEPR Discussion Papers 1088, C.E.P.R. Discussion Papers.
  12. Hettich, Walter & Winer, Stanley L, 1988. "Economic and Political Foundations of Tax Structure," American Economic Review, American Economic Association, vol. 78(4), pages 701-12, September.
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Cited by:
  1. Heinemann, Friedrich, 2002. "Factor Mobility, Government Debt and the Decline in Public Investment," ZEW Discussion Papers 02-19, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  2. Bernoth, Kerstin & Hagen, Jürgen von & Schuknecht, Ludger, 2006. "Sovereign Risk Premiums in the European Government Bond Market," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 151, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
  3. Philipp Paulus, 2004. "The fiscal stability impact of monetary unions - looking beneath the Stability Pact debate," Otto-Wolff-Institut Discussion Paper Series 05/2004, Otto-Wolff-Institut für Wirtschaftsordnung, Köln, Deutschland.
  4. 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 01/2006, Otto-Wolff-Institut für Wirtschaftsordnung, Köln, Deutschland.

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