Fiscal Policy and Financial Markets

26 Pages Posted: 3 Mar 2006

See all articles by Bernardin Akitoby

Bernardin Akitoby

International Monetary Fund (IMF) - Fiscal Affairs Department

Thomas Stratmann

George Mason University - Buchanan Center Political Economy; George Mason University - Mercatus Center; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: January 2006

Abstract

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.

Keywords: Fiscal policy, sovereign risk, spreads, bond markets, emerging markets

JEL Classification: E62, G15, H39, H63

Suggested Citation

Akitoby, Bernardin and Stratmann, Thomas, Fiscal Policy and Financial Markets (January 2006). IMF Working Paper No. 06/16, Available at SSRN: https://ssrn.com/abstract=888161

Bernardin Akitoby (Contact Author)

International Monetary Fund (IMF) - Fiscal Affairs Department ( email )

700 19th Street, NW
Washington, DC 20431
United States

Thomas Stratmann

George Mason University - Buchanan Center Political Economy ( email )

4400 University Drive
Fairfax, VA 22030
United States
703-993-2330 (Phone)

George Mason University - Mercatus Center ( email )

3434 Washington Blvd., 4th Floor
Arlington, VA 22201
United States

HOME PAGE: http://www.mercatus.org/scholars/thomas-stratmann

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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