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The rewards of fiscal consolidations: Sovereign spreads and confidence effects

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  • David, Antonio C.
  • Guajardo, Jaime
  • Yepez, Juan F.

Abstract

This paper investigates the effects of fiscal consolidation announcements on sovereign spreads using high frequency data for 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 barely decline after fiscal announcements from the executive branch. Nonetheless, spreads decline significantly following news that austerity measures have been approved by the legislature (congress or parliament), particularly in economies with high sovereign spreads, debt levels, and low credit-risk ratings. These effects are even larger in the presence of an IMF program. In addition, we find that consolidation announcements are less contractionary when sovereign spreads decline. The reduction in output is a third of the counterfactual case in which spreads do not respond to announcements. These results show that confidence effects, in the form of lower sovereign spreads, are an important transmission channel of fiscal policy actions. 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.

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  • David, Antonio C. & Guajardo, Jaime & Yepez, Juan F., 2022. "The rewards of fiscal consolidations: Sovereign spreads and confidence effects," Journal of International Money and Finance, Elsevier, vol. 123(C).
    • Handle: RePEc:eee:jimfin:v:123:y:2022:i:c:s0261560622000055
    DOI: 10.1016/j.jimonfin.2022.102602
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    1. Siming Liu & Hewei Shen, 2022. "Fiscal Commitment and Sovereign Default Risk," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 46, pages 98-123, October.
    2. Magud, Nicolas E. & Pienknagura, Samuel, 2024. "The return of expansionary austerity: Firms' investment response to fiscal adjustments in emerging markets," Journal of International Money and Finance, Elsevier, vol. 143(C).
    3. Vybhavi Balasundharam & Olivier Basdevant & Dalmacio Benicio & Andrew Ceber & Yujin Kim & Luca Mazzone & Hoda Selim & Yongzheng Yang, 2023. "Fiscal Consolidation: Taking Stock of Success Factors, Impact, and Design," IMF Working Papers 2023/063, International Monetary Fund.
    4. Manuel González-Astudillo & Juan Guerra-Salas & Avi Lipton, 2024. "Fiscal Consolidations in Commodity-Exporting Countries: A DSGE Perspective," Working Papers Central Bank of Chile 1015, Central Bank of Chile.
    5. Shiu‐Sheng Chen, 2023. "A direct approach to Kilian–Lewis style counterfactual analysis in vector autoregression models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 38(7), pages 1068-1076, November.
    6. Anzoategui, Diego, 2022. "Sovereign spreads and the effects of fiscal austerity," Journal of International Economics, Elsevier, vol. 139(C).
    7. Fontana, Olimpia & Sau, Lino, 2023. "Expansionary Austerity in Europe: Finally an Oxymoron?," Department of Economics and Statistics Cognetti de Martiis. Working Papers 202317, University of Turin.
    8. Hatchondo, Juan Carlos & Martinez, Leonardo & Roch, Francisco, 2022. "Numerical fiscal rules for economic unions: The role of sovereign spreads," Economics Letters, Elsevier, vol. 210(C).
    9. Valencia, Oscar & Gamboa-Arbeláez, Juliana & Sánchez, Gustavo, 2023. "Debt Erosion: Asymmetric Response to Demand and Supply Shocks," IDB Publications (Working Papers) 12978, Inter-American Development Bank.
    10. Juan Carlos Hatchondo & Mr. Leonardo Martinez & Cesar Sosa Padilla, 2020. "Sovereign Debt Standstills," IMF Working Papers 2020/290, International Monetary Fund.
    11. Paternesi Meloni, Walter & Romaniello, Davide & Stirati, Antonella, 2022. "Inflation and the NAIRU: assessing the role of long-term unemployment as a cause of hysteresis," Economic Modelling, Elsevier, vol. 113(C).
    12. Beetsma, Roel & Furtuna, Oana & Giuliodori, Massimo & Mumtaz, Haroon, 2021. "Revenue- versus spending-based fiscal consolidation announcements: Multipliers and follow-up," Journal of International Economics, Elsevier, vol. 131(C).
    13. Hayley Pallan, 2022. "Sovereign Spreads and Corporate Taxation," IHEID Working Papers 15-2022, Economics Section, The Graduate Institute of International Studies.
    14. Siming Liu & Hewei Shen, 2022. "Fiscal Commitment and Sovereign Default Risk," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 46, pages 98-123, October.
    15. Ardanaz, Martín & Cavallo, Eduardo A. & Izquierdo, Alejandro & Puig, Jorge, 2021. "The Output Effects of Fiscal Consolidations: Does Spending Composition Matter?," IDB Publications (Working Papers) 11857, Inter-American Development Bank.
    16. Huixin Bi & Sarah Zubairy, 2020. "Public Pension Reforms and Fiscal Foresight: Narrative Evidence and Aggregate Implications," Research Working Paper RWP 20-06, Federal Reserve Bank of Kansas City.
    17. Fernando Arce & Jan Morgan & Nicolas Werquin, 2024. "Tax Revolts and Sovereign Defaults," Working Paper Series WP 2024-07, Federal Reserve Bank of Chicago.

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    More about this item

    Keywords

    Sovereign spreads; Emerging markets; Fiscal consolidation;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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