Countries’ fiscal and macroeconomic policies therefore, affect interest rates not so much directly, but rather indirectly by influencing the magnitude of the spillover effects from global factors. degruyter.com uses cookies to store information that enables us to optimize our website and make browsing more comfortable for you. The second principal component should be a variable which is driven by the same common shocks but not collinear with the monetary stance.
We now briefly discuss the results obtained when including the more recent sample. We interpret these results as a further validation of our interpretation for the estimated factors.
However, the results point also to an increase in the sensitivity of interest rates to domestic debt after the global crisis. As mentioned in the text, interest rates “r” are measured after the release of the forecasts in order to avoid reverse causality from interest rates to macroeconomic and fiscal variables. Our empirical model follows the insights of recent literature that analyzes cross-sectional dependence in large panel.
2012). As a second exercise, we measure the impact of fiscal policy on the yield spreads measured as the difference between the ten years yield and the yield on a risk-free asset of the same maturity (r–rB). In Section 4.2 we discuss the estimation of the unobserved factors and refer the reader to Section 9, Technical Appendix A for more details. We have found some mild evidence that this might be the case when performing the estimates with rolling windows (see Section 5.2).
Laubach, Thomas. Bai, Jushan. Gonçalves Silvia, and Benoit Perron. Our results show that long-term interest rates are mainly driven by two global factors, which explain almost 70 percent of their variance of interest rates.
2012. Second, since domestic policies will not have large direct impact on borrowing costs, but rather indirectly through global factors, unfavorable interest spillovers can have negative implications for countries with larger external vulnerabilities and growing debt burden.
2006. Laubach (2009) shows that to correctly capture the effects of fiscal policy on interest rates, it is important to use long-term (5-year head) projections of both fiscal policy and interest rates, which are less likely to be influenced by business cycle considerations.
Journal of Macroeconomics publishes significant research and scholarship in theoretical and applied macroeconomics. As for the magnitude, the effect is smaller than the standard FE estimator (column 1): a 1 percent increase in public debt increases long-term interest rates by around 1 basis point. This third factor tracks very closely the Chicago Board Options Exchange Market Volatility Index (VIX), which is commonly considered an indicator of global risk aversion. Since the ex-ante real long term yield is unobservable, as in Ardagna, Caselli, and Lane (2007) we construct it from the data.
(2014) (GSS) which allows for factor structure of the regressors as well as lagged dependent variable as in Greenaway-McGrevy, Han, and Sul (2012) (column 3). Overall, we find that using standard panel techniques provides results that are similar to those found in previous literature.
We have decided not to include the real-time output gap for two reasons.
Table 7 reports the results of this exercise. MP is the Moon and Perron (2004) panel unit root test based on two extracted factors from the variable. The table shows the results of estimating equation (7) using the real interest rate (column 1) and sovereign spreads (column 2) as dependent variables. The global financial crisis with its adverse effects on public finances has revived the debate on the link between fiscal policy and interest rates. The papers more closely related to our work are Reinhart and Sack (2000), Chinn and Frankel (2007), Ardagna, Caselli, and Lane (2007). However we also show that long-term interest rates are affected heterogeneously by these common factors, which have larger impact on countries with macroeconomic vulnerabilities. We thus construct a real-time dataset based on macroeconomic projections collected from several vintages of the OECD economic outlook. After the introduction of the common currency, the exchange rate risk among EMU countries has disappeared and Germany has acquired the “status” of safe haven [see Schuknecht, von Hagen, and Wolswijk (2011)]. Laubach (2009) also includes a measure of real-time output gap to control for cyclical factor. “Testing for a Unit Root in Panels with Dynamic Factors.” Journal of Econometrics 122 (1): 81–126. “Dynamic Panel Analysis under Cross-Sectional Dependence.” Political Analysis 22 (2): 258–273. 2012. We notice that the share of variance explained by the first principal component diminishes over time until the crisis, while the share of variance explained by the second factor increases.
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They are adjusted for the exchange rate risk following Codogno, Favero, and Missale (2003). Robust t-statistics in brackets; ***p<0.01, **p<0.05, *p<0.1.
“Yield Spreads on EMU Government Bonds.”, Eichengreen, Barry, Ashoka Mody, Milan Nedeljkovic, and Lucio Sarno. We notice that the results are remarkably stable, with the expected short-term interest rate and the debt to GDP ratio being consistently significant and of similar magnitude.
21A stronger evidence of increase in the importance of the idiosyncratic components of debt and deficit is visible when looking at sovereign risk rather than long-term interest rates. 27While the Chinn and Ito (2006) index measures de Jure financial integration, the level of long-term nominal interest rates can be interpreted as a measure of de Facto financial integration. We confirm the importance of accounting for global factors, but the FAP again performs better than the 2FE as shown by the improvement in the CSD statistics (from –2.10 to –1.23). Fiscal policy leads to an immediate change in the demand for goods and services in the market. for relevant news, product releases and more. They are correlated with measures of initial capital markets integration, current account imbalances and economic and institutional fragility. 28In terms of our theoretical model – equation (4) – the responsiveness of the domestic interest rates to the global factors are given by δki=λkir−βλkiX.
15The significance of the results is not affected by the bootstrap correction. They find that a one percentage increase in the budget deficit to GDP increases interest rates by 9 basis points in the OECD and by 12 basis points in the G7. The importance of the cross-sectional correlation among our variables of interest can be observed when looking at the behavior of long-term interest rates in our sample (Figure 1). The objective of this paper is thus to analyze the impact of domestic fiscal policy on sovereign interest rates in a broad panel of OECD countries, by using a framework which can accommodate both the existence of common sources of fluctuations as well as heterogeneous responses to these external factors.
Cambridge, UK: Cambridge University Press. 2014. In column 1, the dependent variable is the first principal component extracted from Wr while the independent variable is the average expected short term interest rate of the countries in the sample. To control for possible structural breaks in the coefficients as a result of the crisis, we report in the first three columns the results excluding the observations before the year 2008, and in the last three columns the results including the latest sample.
Following the discussion in Laubach (2009), the effect of 1 percent increase in public debt to GDP on interest rates is given by the formula: (1–s)cs/k2 where s=0.33 is the capital share on national income; k=2.5 is the capital-output ratio; c=0.6 is the degree of crowding out. “Budget Deficits, National Savings, and Interest Rates.” Brookings Papers on Economic Activity (35): 2004.
We then show the evolution of the coefficients in the main regression over time and check for possible breaks. Our results show that, when we account for cross-sectional dependence, the impact of domestic variables on long-term interest rates diminishes significantly. Fiscal policy alone will not dictate a country's current balance of payments status; however, it can affect this economic measure.
We also check whether, as suggested by Ardagna, Caselli, and Lane (2007), the effect of public debt is non-linear carrying stronger effects after a given level (see Table 13). “New Evidence on the Interest Rate Effects of Budget Deficits and Debt.”, Journal of the European Economic Association, Longstaff, Francis A., Jun Pan, Lasse H. Pedersen, and Kenneth J. Singleton. They also include cross-sectional averages of the fiscal variables to control for the presence of global factors. Hence, even if on one hand economic and financial integration and policy coordination reduce the impact of national policies on borrowing costs, on the other hand changes in global conditions expose more vulnerable countries to a sudden reversal of fortunes. Beside lower impact of public deficits, we also find that the effect of public debt on long-term interest rates is smaller compared to previous estimates. If in fact global fiscal expansions take place in periods of recessions when investors also pull out capital from abroad, then running a high current account deficit might aggravate capital scarcity and induce higher increase in interest rates. “Government Bond Risk Premiums in the EU Rivisited: The Impact of the Financial Crisis.” European Journal of Political Economy 27 (1): 36–43. Similar results can be found in Claeys, Rosina, and Suriñach (2012). We show that the importance of the idiosyncratic factors is time-varying. Under our frame work, we find that the importance of domestic variables in explaining long-term interest rates is weakened.
Bernoth, Kerstin, Jurgen Von Hagen, and Ludger Schuknecht.
Cambridge, UK: Cambridge University Press.
2009. As for the dependent variable we use the realized ten years yield on sovereign bonds (rit). The compression of long-term interest rates which occurred in OECD countries prior to the crisis could be explained by the fiscal retrenchment which took place among industrialized countries at the beginning of the nineties and the lowering of inflation premia due to a shift to credible inflation targets. A better measure could be the Net Financial Liabilities of the General Government.
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