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Government borrowing cost and budget deficits: is investment spending different?

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  • Jemima Peppel-Srebrny

Abstract

We find that bond markets charge significantly higher interest rates for deficits due to higher government current spending than for deficits due to higher government investment. Thus, from a sovereign risk perspective, not all government budget deficits are created equal. To show this, we use a panel regression approach on European Commission data for 31 advanced economies from 1990 onwards. Econometrically, we address potential endogeneity by using forecasts of fiscal variables and by instrumental variable methods. Based on our preferred specifications, a higher deficit solely due to higher government investment would in fact decrease long-term government bond yields. These findings suggest that the policy debate about fiscal sustainability and fiscal rules should, at the very least, distinguish budget deficits that are the result of investment from those that are not. Revised September 2020

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  • Jemima Peppel-Srebrny, 2020. "Government borrowing cost and budget deficits: is investment spending different?," Economics Series Working Papers 827, University of Oxford, Department of Economics.
    • Handle: RePEc:oxf:wpaper:827
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    3. Jemima Peppel-Srebrny, 2018. "Government borrowing cost and balance sheets: do assets matter?," Economics Series Working Papers 860, University of Oxford, Department of Economics.

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    More about this item

    Keywords

    Government budget deficits; government investment; fiscal policy; long-term interest rates; OECD countries;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H54 - Public Economics - - National Government Expenditures and Related Policies - - - Infrastructures
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus

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