The Rewards of Fiscal Consolidation: Sovereign Spreads and Confidence Effects

29 Pages Posted: 28 Jul 2019

See all articles by Antonio C. David

Antonio C. David

World Bank - Policy Research Department; International Monetary Fund (IMF)

Jaime Guajardo

International Monetary Fund (IMF)

Juan F. Yépez

International Monetary Fund (IMF)

Date Written: July 2019

Abstract

This paper investigates the effects of fiscal consolidation announcements on sovereign spreads in a panel of 21 emerging market economies during 2000-18. We construct a novel dataset using a global news database to identify the precise announcement date of fiscal consolidation actions. Our results show that sovereign spreads decline significantly following news that austerity measures have been approved by the legislature (congress or parliament), in periods of high sovereign spreads or in countries under an IMF program. In addition, consolidation announcements are less contractionary when sovereign spreads decline, with the reduction in output being half of the counterfactual case in which spreads do not respond to announcements. These results constitute direct evidence that confidence effects, in the form of lower sovereign spreads, are an important transmission channel of fiscal shocks. We also find that the role of confidence effects increases with the level of spreads such that countries with high spread levels stand to benefit the most from putting in place credible austerity packages.

Keywords: Fiscal consolidation, Fiscal policy, Indicators of economic activity, Tax increases, Tax reforms, Sovereign spreads, emerging markets, austerity., austerity, basis point, austerity measure, IMF program, counterfactual

JEL Classification: E62, H30, E01, K34, G21, G12

Suggested Citation

David, Antonio C. and Guajardo, Jaime and Yépez, Juan F., The Rewards of Fiscal Consolidation: Sovereign Spreads and Confidence Effects (July 2019). IMF Working Paper No. 19/141. Available at SSRN: https://ssrn.com/abstract=3427677

Antonio C. David (Contact Author)

World Bank - Policy Research Department ( email )

1818 H Street
Washington, DC 20433
United States

International Monetary Fund (IMF) ( email )

700 19th Street N.W.
Washington, DC 20431
United States

Jaime Guajardo

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Juan F. Yépez

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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