Public Deficits and Borrowing Costs: The Missing Half of Market Discipline

24 Pages Posted: 16 Oct 2002

See all articles by Friedrich Heinemann

Friedrich Heinemann

ZEW – Leibniz Centre for European Economic Research; University of Heidelberg - Alfred Weber Institute for Economics

Viktor Winschel

ETH Zürich

Date Written: March 15, 2001

Abstract

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.

Keywords: market discipline, borrowing costs, EMU, public debt, government deficits

JEL Classification: H62

Suggested Citation

Heinemann, Friedrich and Winschel, Viktor, Public Deficits and Borrowing Costs: The Missing Half of Market Discipline (March 15, 2001). ZEW Discussion Paper No. 01-16, Available at SSRN: https://ssrn.com/abstract=331083 or http://dx.doi.org/10.2139/ssrn.331083

Friedrich Heinemann (Contact Author)

ZEW – Leibniz Centre for European Economic Research ( email )

P.O. Box 10 34 43
L 7,1
D-68034 Mannheim, 68034
Germany

HOME PAGE: http://www.zew.de

University of Heidelberg - Alfred Weber Institute for Economics ( email )

Grabengasse 14
Heidelberg, D-69117
Germany

Viktor Winschel

ETH Zürich ( email )

Zürichbergstrasse 18
Zürich, Zürich 8'32
Switzerland
+49-1797621055 (Phone)

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