IMF Working Papers

Fiscal Policy and Financial Markets

By Bernardin Akitoby, Thomas Stratmann

January 1, 2006

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Format: Chicago

Bernardin Akitoby, and Thomas Stratmann. "Fiscal Policy and Financial Markets", IMF Working Papers 2006, 016 (2006), accessed April 27, 2025, https://0-doi-org.library.svsu.edu/10.5089/9781451862768.001

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper introduces fiscal policy in a model of sovereign risk spreads ("spreads"). Using panel data from emerging market countries, we find that reductions in public expenditure are a more powerful tool for reducing spreads than increases in revenues. Specifically, cuts in current spending lower spreads by more than cuts in investment spending, and they also lower spreads by more than increases in revenue. We also show that debt-financed current spending increases sovereign risk by more than tax-financed current spending, suggesting that international investors have some preference for the latter. In line with the empirical literature on the determinants of spreads, we find that liquidity and solvency indicators, as well as macroeconomic fundamentals, are also important determinants of spreads.

Subject: Current spending, Expenditure, Financial crises, Fiscal consolidation, Fiscal policy, Inflation, Prices

Keywords: A. fiscal policy, Arellano-bond estimate, Bond markets, Borrowing cost, Country spread, Current spending, Debt, Emerging markets, Financial markets treatment, Fiscal consolidation, Fiscal policy, Fiscal policy variable, Global, Inflation, Inflation rate, Short-run spread, Short-term debt, Sovereign risk, Sovereign spread, Spread, Spreads, Stochastic model, Stripped spread, WP

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