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Public deficits and borrowing costs: the missing half of market discipline

  • Heinemann, Friedrich
  • Winschel, Viktor

EMU driven interest rate convergence has led to a significant reduction of borrowing costs for some European governments in the second half of the nineties. The paper deals with the possible consequences for deficit behaviour. Although the impact of interest rates on deficits is a crucial element of the market discipline hypothesis it has widely been neglected in the literature. In the theoretical part, a standard political economic model of budgetary policy (Hettich-Winer) is adapted. It turns out that borrowing costs, measured as the interest-growth-differential, and the level of public debt should be important determinants for public deficits. The econometric part tests these predictions for a panel of OECD countries. The results indicate that there is indeed a significant impact of borrowing costs on the primary surplus. This impact is characterised by a robust asymmetry: Reactions in times of increasing borrowing costs are more pronounced than in times of relaxing conditions.

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Paper provided by ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research in its series ZEW Discussion Papers with number 01-16.

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Date of creation: 2001
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Handle: RePEc:zbw:zewdip:5371
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  1. Alberto Alesina & Roberto Perotti, 1995. "The Political Economy of Budget Deficits," IMF Staff Papers, Palgrave Macmillan, vol. 42(1), pages 1-31, March.
  2. Giovannini, Alberto & Piga, Gustavo, 1992. "Understanding the High Interest Rates on Italian Government Securities," CEPR Discussion Papers 720, C.E.P.R. Discussion Papers.
  3. Hettich, Walter & Winer, Stanley L, 1988. "Economic and Political Foundations of Tax Structure," American Economic Review, American Economic Association, vol. 78(4), pages 701-12, September.
  4. Jacob A. Frenkel & Morris Goldstein, 1990. "Monetary Policy in an Emerging European Economic and Monetary Union; Key Issues," IMF Working Papers 90/73, International Monetary Fund.
  5. Hettich, W. & Winter, S.L., 1993. "The Political Economy of Taxation," Papers 93-2, Carleton - Business Administration.
  6. Carlo Ambrogio Favero & Francesco Giavazzi & Luigi Spaventa, . "High Yielders: the Spread on German Interest Rates," Working Papers 102, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  7. Hettich, Walter & Winer, Stanley, 1984. "A positive model of tax structure," Journal of Public Economics, Elsevier, vol. 24(1), pages 67-87, June.
  8. Francesco P. Mongelli, 1997. "Effects of the European Economic and Monetary Union (EMU)on Taxation and Interest Spending of National Governments," IMF Working Papers 97/93, International Monetary Fund.
  9. Timothy D. Lane, 1993. "Market Discipline," IMF Staff Papers, Palgrave Macmillan, vol. 40(1), pages 53-88, March.
  10. Eichengreen, Barry & Bayoumi, Tamim, 1994. "The political economy of fiscal restrictions: Implications for Europe from the United States," European Economic Review, Elsevier, vol. 38(3-4), pages 783-791, April.
  11. Metcalf, Gilbert E., 1993. "Federal taxation and the supply of state debt," Journal of Public Economics, Elsevier, vol. 51(3), pages 269-285, July.
  12. Bayoumi, Tamim & Goldstein, Morris & Woglom, Geoffrey, 1995. "Do Credit Markets Discipline Sovereign Borrowers? Evidence from US States," CEPR Discussion Papers 1088, C.E.P.R. Discussion Papers.
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