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Financial and real effects of fiscal risk

Author

Listed:
  • Denis Gorea
  • Ding Xuan Ng
  • Fabrizio Zampolli

Abstract

This paper estimates the macroeconomic and financial effects of fiscal risk shocks using a novel identification from bond yields. We first recover country-specific fiscal risk shocks from a daily Bayesian VAR model in sovereign and safe corporate bond yields, identified via contemporaneous sign restrictions that capture portfolio rebalancing away from government debt toward private safe assets. We then estimate the effects of these shocks using a local-projections framework applied to a monthly panel of twelve economies. Fiscal risk shocks generate stagflationary dynamics. Inflation and inflation expectations rise on impact, while industrial production increases only temporarily before declining persistently. Sovereign yield curves steepen, exchange rates depreciate and equity prices fall. These effects are significantly stronger when monetary policy remains accommodative– leading to persistently negative real interest rates– and when sovereign risk premia are already elevated.

Suggested Citation

  • Denis Gorea & Ding Xuan Ng & Fabrizio Zampolli, 2026. "Financial and real effects of fiscal risk," BIS Working Papers 1364, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:1364
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    Keywords

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    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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