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Fiscal Rules and Financial Systems: Complements or Substitutes?

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  • Juan Gabriel Fernández
  • Francisco Parro

Abstract

We study the effect of fiscal rules on a country's credit rating and their interaction with financial development. We build a rich set of panel data, which includes a novel index for the strength of fiscal rules. We find a positive and significant effect of fiscal rules on sovereign ratings. We also find that this effect is attenuated in economies with a more developed domestic financial system. Therefore, financial markets act as a substitute for fiscal rules in lowering the default risk assessed by credit rating agencies. This substitution effect between fiscal rules and financial development is mostly triggered through the monitoring and enforcement dimension of fiscal rules.

Suggested Citation

  • Juan Gabriel Fernández & Francisco Parro, 2019. "Fiscal Rules and Financial Systems: Complements or Substitutes?," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 81(3), pages 588-616, June.
  • Handle: RePEc:bla:obuest:v:81:y:2019:i:3:p:588-616
    DOI: 10.1111/obes.12279
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    File URL: https://doi.org/10.1111/obes.12279
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