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Have market views on the sustainability of fiscal burdens influenced monetary authorities' credibility?

  • Gabriele Galati
  • John Lewis
  • Steven Poelhekke
  • Chen Zhou

During the Great Crisis, most governments in industrial countries supported their domestic financial sector under stress and responded to strong declines in output growth with fiscal stimulus packages. Starting in 2010, attention focused on the sustainability of the resulting debt burdens. We conduct an empirical study to test whether in the United States, the euro area and the United Kingdom, views on the sustainability of fiscal burdens have influenced markets' assessment of central banks' commitment to price stability. Using a daily measure of inflation expectations extracted from nominal and indexed-linked government bonds, or inflation swaps, we test whether these react to alternative measures of fiscal burdens. These include rescue package announcements, credit default swap (CDS) spreads and changes in either the outlook or the credit rating of governments. We find no evidence of a significant effect of market participants' perceptions of fiscal burdens on long-term inflation expectations in the United States, the euro area and the United Kingdom. These results are broadly consistent with the view that long term inflation expectations have remained well anchored.

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Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 304.

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Date of creation: Jul 2011
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Handle: RePEc:dnb:dnbwpp:304
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