Fiscal Policy and Financial Markets
IMF Working Papers, January 1, 2006
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Bibliographic details
- Authors: Bernardin Akitoby, Thomas Stratmann
- Published: January 1, 2006
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451862768.001
Summary and main findings
- Introduces fiscal policy in a model of sovereign risk spreads ("spreads").
- Using panel data from emerging market countries, reductions in public expenditure are a more powerful tool for reducing spreads than increases in revenues.
- Cuts in current spending lower spreads by more than cuts in investment spending.
- Cuts in current spending lower spreads by more than increases in revenue.
- Debt-financed current spending increases sovereign risk by more than tax-financed current spending, suggesting that international investors have some preference for tax-financed current spending.
- Liquidity and solvency indicators, as well as macroeconomic fundamentals, are also important determinants of spreads, in line with the empirical literature on the determinants of spreads.
Model, data, and methodology
- Introduces fiscal policy into a model of sovereign risk spreads.
- Empirical analysis uses panel data from emerging market countries.
- Methodological keywords include Arellano-bond estimate and stochastic model.
Policy implications and interpretation
- Fiscal consolidation via reductions in public expenditure—particularly cuts in current spending—can be more effective at reducing sovereign spreads than revenue increases.
- Financing composition matters: debt-financed current spending raises sovereign risk more than tax-financed current spending, implying investor preferences over financing methods.
- Policymakers should consider liquidity and solvency indicators and broader macroeconomic fundamentals when assessing the impact of fiscal actions on sovereign spreads.