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Expected fiscal policy and interest rates in open economy

This paper reconsiders the long term effect of fiscal policy on interest rates using a real-time dataset of macroeconomic and fiscal variables in a panel of 17 OECD countries over the period 1989-2009. We show that, after controlling for cross sectional dependence using a Factor Augmented Panel, interest rates are mostly related to global factors. Among domestic fiscal variables, the level of expected public debt mantains a positive correlation with interest rates, while among the global factors, the aggregate monetary and fiscal stance play a quantitatively sizeable role. We then analyze how impulses from the aggregate fiscal stance influence each country's interest rates. We find that these effects are modest in large economies and particularly strong in economies characterized by low initial financial integration, leading the way to a novel interpretation of the divergent behaviour of interest rates in the recent financial crisis.

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File URL: http://repec.graduateinstitute.ch/pdfs/Working_papers/HEIDWP07-2011.pdf
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Paper provided by Economics Section, The Graduate Institute of International Studies in its series IHEID Working Papers with number 07-2011.

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Length: 70 pages
Date of creation: 03 Mar 2011
Date of revision:
Handle: RePEc:gii:giihei:heidwp07-2011
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  1. Jushan Bai & Serena Ng, 2000. "Determining the Number of Factors in Approximate Factor Models," Boston College Working Papers in Economics 440, Boston College Department of Economics.
  2. Eric M. Engen & R. Glenn Hubbard, 2004. "Federal Government Debt and Interest Rates," NBER Working Papers 10681, National Bureau of Economic Research, Inc.
  3. Bernoth, Kerstin & von Hagen, Jürgen & Schuknecht, Ludger, 2004. "Sovereign risk premia in the European government bond market," Working Paper Series 0369, European Central Bank.
  4. Dornbusch, Rudi, 1997. "Fiscal Aspects of Monetary Integration," American Economic Review, American Economic Association, vol. 87(2), pages 221-23, May.
  5. Alberto Alesina & Roberto Perotti, 1995. "Fiscal Expansions and Fiscal Adjustments in OECD Countries," NBER Working Papers 5214, National Bureau of Economic Research, Inc.
  6. Barro, R.J. & Martin, X.S., 1990. "World Real Interest Rates," RCER Working Papers 227, University of Rochester - Center for Economic Research (RCER).
    • Robert J. Barro & Xavier Sala-i-Martin, 1990. "World Real Interest Rates," NBER Chapters, in: NBER Macroeconomics Annual 1990, Volume 5, pages 15-74 National Bureau of Economic Research, Inc.
  7. Bertola, Giuseppe & Drazen, Allan, 1993. "Trigger Points and Budget Cuts: Explaining the Effects of Fiscal Austerity," American Economic Review, American Economic Association, vol. 83(1), pages 11-26, March.
  8. Douglas W. Elmendorf & N. Gregory Mankiw, 1998. "Government Debt," NBER Working Papers 6470, National Bureau of Economic Research, Inc.
    • Elmendorf, Douglas W. & Gregory Mankiw, N., 1999. "Government debt," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 25, pages 1615-1669 Elsevier.
  9. Ardagna, Silvia, 2009. "Financial markets' behavior around episodes of large changes in the fiscal stance," European Economic Review, Elsevier, vol. 53(1), pages 37-55, January.
  10. Francesco Caselli, 1998. "Fiscal Discipline and the Cost of Public Debt Service: Some Estimates for OECD Countries," IMF Working Papers 98/55, International Monetary Fund.
  11. International Monetary Fund, 2010. "Fiscal Policy and the Current Account," IMF Working Papers 10/121, International Monetary Fund.
  12. Antonio Afonso, 2010. "Long-term government bond yields and economic forecasts: evidence for the EU," Applied Economics Letters, Taylor & Francis Journals, vol. 17(15), pages 1437-1441.
  13. Riccardo Faini, 2006. "Fiscal policy and interest rates in Europe," Economic Policy, CEPR;CES;MSH, vol. 21(47), pages 443-489, 07.
  14. R. Glenn Hubbard & Eric M. Engen, 2004. "Federal Government Debt and Interest Rates," Working Papers 50018, American Enterprise Institute.
  15. Ali Abbas, S.M. & Bouhga-Hagbe, Jacques & Fatás, Antonio & Mauro, Paolo & Velloso, Ricardo C., 2010. "Fiscal Policy and the Current Account," CEPR Discussion Papers 7859, C.E.P.R. Discussion Papers.
  16. Ford, Robert & Laxton, Douglas, 1999. "World Public Debt and Real Interest Rates," Oxford Review of Economic Policy, Oxford University Press, vol. 15(2), pages 77-94, Summer.
  17. Roel Beetsma & Massimo Giuliodori, 2010. "Fiscal adjustment to cyclical developments in the OECD: an empirical analysis based on real-time data," Oxford Economic Papers, Oxford University Press, vol. 62(3), pages 419-441, July.
  18. Balduzzi, Pierluigi & Corsetti, Giancarlo & Foresi, Silverio, 1997. "Yield-curve movements and fiscal retrenchments," European Economic Review, Elsevier, vol. 41(9), pages 1675-1685, December.
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