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Fiscal Policy and the Term Structure: Evidence from the Case of Italy in the EMS and the EMU Periods

  • Favero, Carlo A.
  • Giglio, Stefano W

We study the relationship between the term structure of interest rates and fiscal policy by considering the Italian case. Empirical analysis has been so far rather inconclusive on this important topic. We abscribe such evidence to three problems: identification, regime-switching and maturity effects. All these aspects are particularly relevant to the Italian case. We propose a parsimonious model with three factors to represent the whole yield curve, and we consider yield differentials between Italian and German Government bonds. To take into account the possibility of regime-switching, we explicitly include a hidden two-state Markov chain that represents market expectations. The model is estimated using Bayesian econometric techniques. We find that government debt and its evolution significantly influence the yield of government bonds, that such effects are maturity dependent and regime-dependent. Hence when investigating the effect of fiscal policy on the term-structure it is of crucial importance to allow for multiple regimes in the estimation.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5793.

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Date of creation: Aug 2006
Date of revision:
Handle: RePEc:cpr:ceprdp:5793
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  1. Favero, Carlo A. & Giavazzi, Francesco & Spaventa, Luigi, 1996. "High Yields: The Spread on German Interest Rates," CEPR Discussion Papers 1330, C.E.P.R. Discussion Papers.
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  9. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May.
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  12. Ardagna, Silvia & Caselli, Francesco & Lane, Timothy, 2004. "Fiscal discipline and the cost of public dept service: some estiames for OECD countries," Working Paper Series 0411, European Central Bank.
  13. Hordahl, Peter & Tristani, Oreste & Vestin, David, 2006. "A joint econometric model of macroeconomic and term-structure dynamics," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 405-444.
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  16. Ardagna, Silvia & Caselli, Francesco & Lane, Timothy, 2004. "Fiscal Discipline and the Cost of Public Debt Service: Some Estimates for OECD Countries," CEPR Discussion Papers 4661, C.E.P.R. Discussion Papers.
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  21. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, vol. 60(4), pages 473-89, October.
  22. Peter Hordahl & Oreste Tristani & David Vestin, 2003. "A joint econometric model of macroeconomic and term structure," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  23. Olivier J. Blanchard & Lawrence H. Summers, 1984. "Perspectives on High World Real Interest Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 15(2), pages 273-334.
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  25. Diebold, Francis X. & Rudebusch, Glenn D. & Borag[caron]an Aruoba, S., 2006. "The macroeconomy and the yield curve: a dynamic latent factor approach," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 309-338.
  26. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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