Fiscal Activism and the Cost of Debt Financing
19 Pages Posted: 20 May 2010
Date Written: April 2010
In this paper, we estimate the impact of changes in fiscal policy regime on the yield curve. In particular, we differentiate between yield curve responses under active and passive fiscal policy regimes (according to the terminology of Leeper 1991). Analyzing US data in the period 1965-2010, we find a statistically significant impact of fiscal policy only for the active policy regime. A one-percentage-point shock in the primary deficit leads typically to a contemporaneous increase in long-term yields of about 10 basis points, and even stronger cumulative effects. No significant impact of deficits on yields is found in the passive fiscal policy regime.
Keywords: Fiscal activism, Markov switching and yield curve
JEL Classification: G12, E62
Suggested Citation: Suggested Citation