The Rewards of Fiscal Consolidation: Sovereign Spreads and Confidence Effects

By Antonio David, Jaime Guajardo, Juan Yepez

July 2, 2019

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Antonio David, Jaime Guajardo, and Juan Yepez. The Rewards of Fiscal Consolidation: Sovereign Spreads and Confidence Effects, (USA: International Monetary Fund, 2019) accessed November 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

This paper investigates the effects of fiscal consolidation announcements on sovereign spreads in a panel of 21 emerging market economies during 2000-18. We construct a novel dataset using a global news database to identify the precise announcement date of fiscal consolidation actions. Our results show that sovereign spreads decline significantly following news that austerity measures have been approved by the legislature (congress or parliament), in periods of high sovereign spreads or in countries under an IMF program. In addition, consolidation announcements are less contractionary when sovereign spreads decline, with the reduction in output being half of the counterfactual case in which spreads do not respond to announcements. These results constitute direct evidence that confidence effects, in the form of lower sovereign spreads, are an important transmission channel of fiscal shocks. We also find that the role of confidence effects increases with the level of spreads such that countries with high spread levels stand to benefit the most from putting in place credible austerity packages.

Subject: Emerging and frontier financial markets, Financial markets, Fiscal consolidation, Fiscal policy, Fiscal risks, Public financial management (PFM)

Keywords: Austerity, Austerity announcement, Austerity measure, Austerity package, Default premium, Economic activity, Emerging and frontier financial markets, Emerging markets, Fiscal consolidation, Fiscal consolidation announcement, Fiscal risks, Global, Sovereign spreads, WP

Publication Details

Pages:

28
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2019/141
Stock No:

WPIEA2019141
ISBN:

9781498317054
ISSN:

1018-5941

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