Fiscal Adjustment and the Costs of Public Debt Service: Evidence from OECD Countries

38 Pages Posted: 16 Jan 2011

See all articles by Christoph A. Schaltegger

Christoph A. Schaltegger

University of St. Gallen - CREMA

Martin Weder

University of Lucerne

Date Written: December 30, 2010

Abstract

We use a panel of 21 OECD countries from 1970 to 2009 to investigate the effects of different fiscal adjustment strategies on long-term interest rates – a key fiscal indicator reflecting the costs of government debt service. A government confronted with high deficits and rising debt will sooner or later need to enact fiscal adjustments in order to avoid solvency problems. Over the last four decades, such measures taken by governments in OECD countries have varied in duration, size, composition and in their success to re-establish fiscal sustainability. Controlling for various economic, fiscal and political factors, we find that the size and the composition of a fiscal adjustment significantly affect interest rates as well as yield spreads. Adjustments that are relatively large and those that primarily depend on expenditure cuts lead to substantially lower long-term interest rates. However, periods of fiscal adjustments do not generally have an influence on interest rates, even if they were successful and led to lower deficits and debt levels. Instead, financial markets only seem to value strict and decisive measures – a clear sign that the government’s pledge to cut the deficit is credible.

Keywords: fiscal adjustment, consolidation policy, government debt, deficit, interest rates

JEL Classification: E62, H08, H60

Suggested Citation

Schaltegger, Christoph A. and Weder, Martin, Fiscal Adjustment and the Costs of Public Debt Service: Evidence from OECD Countries (December 30, 2010). CESifo Working Paper Series No. 3297. Available at SSRN: https://ssrn.com/abstract=1739569

Christoph A. Schaltegger (Contact Author)

University of St. Gallen - CREMA ( email )

Varnbuelstr. 14
Saint Gallen, St. Gallen CH-9000
Switzerland

Martin Weder

University of Lucerne

Hofstrasse 9
P.O. Box 7464
Luzern 7, CH - 6000
Switzerland

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