Government Borrowing Costs Research Articles

Fiscal rules, capital controls, and cross-border financial integration

This paper shows that adopting fiscal rules (FRs) decreases the use of capital controls and increases cross-border financial integration. This result is robust to alternative measures of fiscal rules, capital controls, and international financial integration — it is also robust to alternative econometric approaches. It also shows that the adoption of fiscal rules increases financial integration. This paper innovatively employs a formal instrumental variables (IV) approach to tackle the endogeneity of the decision to adopt fiscal rules. The adoption of FRs is instrumented using the age dependency ratio (ADR). This strategy is particularly effective because adopting FRs is more likely when the ADR is relatively low, a finding well established in the empirical literature. Governments impose capital controls to channel domestic savings into the public sector, finance their excessive fiscal deficits, and reduce their borrowing costs. However, the uncertainty over the government's future fiscal policies may lead to capital flight. FRs ‘tie the hands’ of governments and induce them to commit themselves to fiscal discipline. Moreover, FRs can also reduce the government's borrowing costs. These effects of FRs render capital controls less necessary and lead policymakers to lift capital controls, resulting in higher cross-border financial integration.

Reprint of “Unveiling the dance of commodity prices and the global financial cycle”

We examine the impact of commodity price changes on the business cycles and capital flows in emerging markets and developing economies (EMDEs), distinguishing between their role as a source of shock and as a channel of transmission of global shocks. Our findings reveal that surges in export prices, triggered by commodity price shocks, boost domestic GDP, an effect further amplified by the endogenous decline of country spreads. However, the effects on capital flows appear muted. Shifts in U.S. monetary policy and global risk appetite drive the global financial cycle in EMDEs. Eased global credit conditions, attributed to looser U.S. monetary policy or lower global risk appetite, lead to a rise in export prices, higher output, a decrease in government borrowing costs, and stimulate greater capital flows. The endogenous response of export prices amplifies the output effects of a more accommodative U.S. monetary policy while country spreads magnify the impact of shifts in global risk appetite.

De-dollarization? Not so fast

De-dollarization refers to the reduction of the reliance of foreign countries on the US dollar. This phenomenon generates concern about the U.S. dollar as a global currency. We construct new data on the currency denomination of central bank currency reserves, foreign exchange transaction volume, denomination of global debt securities, and the invoicing of trade. This paper presents empirical evidence suggesting that these concerns are misplaced, finding US dollar dominance remains unchanged up through late 2023, nearly two years after the 2022 Russian invasion of Ukraine and several years after the 2020 COVID-19 pandemic. Meanwhile euro and renminbi influence have since declined. These findings have implications for reserve currency resilience, U.S. dollar dominance, U.S. sanctions policy, international spillovers of U.S. monetary policy, and U.S. government borrowing costs.

Unveiling the dance of commodity prices and the global financial cycle

We examine the impact of commodity price changes on the business cycles and capital flows in emerging markets and developing economies (EMDEs), distinguishing between their role as a source of shock and as a channel of transmission of global shocks. Our findings reveal that surges in export prices, triggered by commodity price shocks, boost domestic GDP, an effect further amplified by the endogenous decline of country spreads. However, the effects on capital flows appear muted. Shifts in U.S. monetary policy and global risk appetite drive the global financial cycle in EMDEs. Eased global credit conditions, attributed to looser U.S. monetary policy or lower global risk appetite, lead to a rise in export prices, higher output, a decrease in government borrowing costs, and stimulate greater capital flows. The endogenous response of export prices amplifies the output effects of a more accommodative U.S. monetary policy while country spreads magnify the impact of shifts in global risk appetite.

ТРАНСФОРМАЦІЯ СВІТОВОЇ ФІНАНСОВОЇ АРХІТЕКТУРИ ПІД ВПЛИВОМ ФІНАНСОВОЇ ГЛОБАЛІЗАЦІЇ

At the current stage of the evolution of the global economy, there is an intensive increase in the pace of financial globalization (FG), which leads to qualitative and quantitative changes in its institutional environment. In parallel, the interaction and interdependence of all components of theglobal financial system is being restructured. Thus, the purpose of the article is to analyze the transformational dynamics of the world financial architecture (WFA) under the influence of financial globalization and to develop a scientific and practical mechanism for regulating WFA transformations in the context of financial integration. To achieve this goal, the author generalizes and expands the scope of study of financial globalization (its positive and negative effects) as a key factor influencing the transformation of the WFA. In this context, the average daily cash flow on the Forex market, general flows (inflows and outflows) of direct foreign investments, export-import operations on international markets, and the pace of development of financial technological innovations (FinTech) were investigated. To make the study more thorough, the author analyzed the transformational processes of WFA after the global economic and financial crisis of 2007-2009, which led to a number of structural shifts and led to the emergence of alternative stabilization mechanisms and sources of international liquidity. In addition, modern trends in the development of the world financial architecture in the conditions of the FG were revealed. Thus, the COVID-19 pandemic highlighted the interconnectedness of financial markets and the vulnerability of economies to external shocks and caused a sharp decline in stock market indices, significant fluctuations in exchange rates and general economic instability. Even more devastating consequences are threatened by a full-scale invasion of russia into Ukraine, which caused a significant slowdown in the economic growth of many countries due to a large-scale break in international production and trade ties, changes in the direction of FDI flows, aggravation of crises on international markets, in particular food and energy, and an increase in labor migration, world inflation. The result of the conducted research was the development of a mechanism for the transformation of the world financial architecture in the conditions of financial globalization. Thus, it was proposed to single out seven main vectors of the transformation of the world financial architecture, including: strengthening of global economic governance; improving the financial safety net; improvement of the political and regulatory framework of the financial system; easing the debt burden and reducing the cost of government borrowing; strengthening regulation and supervision of banking and non-banking financial institutions; restructuring of the global tax system, increasing international public development.

Economic Consequences of the Cost of Government Borrowing in European Transition Economies

Abstract Given the need of transition economies to fund the investments necessary for development partly through borrowing, this paper investigates empirically the economic consequences of the government cost of borrowing for European transition economies during the period 2003-2016. The investigation analyses the impact of sovereign borrowing costs, in turn, on interest rates on loans to businesses and households, on the growth rates of investment and consumption, and, ultimately, on general economic activity. By utilizing a panel VAR technique our results indicate that consequent upon a positive shock to the cost of sovereign borrowing, the cost of borrowing for loans to both Non-Financial Corporations (NFCs) and households increases. We find that the price transmission from government borrowing costs to the private sector is at play with respect not only to borrowing rates but also to macroeconomic activity at large. Following an increase in sovereign borrowing costs, we observe substantial negative responses in the growth rates of investment, household consumption, and GDP growth. Also, while a price of borrowing increase for NFCs is found to negatively affect investment, household consumption is unaffected by an increase in household borrowing rates. These findings have valuable policy implications for policymakers and stakeholders in transition economies. Specifically, the results suggest that efforts to reduce the cost of sovereign borrowing could have a positive impact on the economy by lowering borrowing costs for households and businesses, promoting investment and consumption, and ultimately boosting economic growth.

Geopolitical Risks and Yield Dynamics in the Australian Sovereign Bond Market

Geopolitical risks and shocks such as military conflicts, terrorist attacks, and war tensions are known to cause significant economic downturns. The main purpose of this paper is to determine the dynamics between Australian sovereign bond yields and geopolitical risk. This is achieved by employing a quantile regression analysis. The findings of this study indicate that the impact of geopolitical risk on Australian sovereign yield dynamics is asymmetrical. Furthermore, an increase in geopolitical risk only impacts short-term yields at extreme regimes. However, the impact is, by and large, insignificant. On the other hand, an increase in geopolitical risk does have a statistically significant positive impact on medium- and long-term yields across most quantiles. Lastly, an increase in geopolitical risk tends to result in a steeper yield curve at the belly of the curve but causes the yield curve to flatten at the long end. This study is the first study that holistically examines the dynamics between geopolitical risk and Australian sovereign bond yields. The study thereby contributes to the body of knowledge on Australian bond yields, specifically, and adds to the sparse body of knowledge on the dynamics between geopolitical risk and sovereign bond yields. The findings of this study have implications for monetary policy makers, given that shifts in sovereign bond yields could impact all three core mandates of the Australian Reserve Bank. Furthermore, changes in the slope of the yieldcurve could be used by monetary policy makers to pre-empt changes in future economic growth. The results of this study also relate to fiscal policy formulation, given that yields directly impact the cost of government borrowing. Lastly, portfolio managers could benefit from the results of this study, as these results provide information on the ability of Australian sovereign bonds to hedge against geopolitical risk.

When it matters to keep promises: Funding of retiree benefit and government borrowing cost

While funding of retiree benefits has become a critical challenge to the fiscal sustainability of U.S. local governments, little is known about the consequences of public expenditures on OPEBs and pensions. This study examines whether and when annual contributions to other post-employment benefits (OPEBs) plans affect government borrowing costs. By reducing unfunded liabilities, OPEB contributions may decrease borrowing costs. As two parts of deferred employee compensation, expenditure tradeoffs may exist between OPEBs and pension contributions. Fiscal capacity can further moderate these expenditure tradeoffs. Results show that, as U.S. city and county governments make more contributions to OPEB plans, they pay lower borrowing costs when the pension contribution is low and when fiscal capacity is low. They pay higher borrowing costs when the pension contribution is high and when fiscal capacity is low. These findings suggest that the savings of borrowing costs from OPEB contributions depend on the tradeoffs between OPEB and pension expenditures and the availability of fiscal resources.

Sovereign Debt Sustainability and Central Bank Credibility

This article surveys the literature on sovereign debt sustainability from its origins in the mid-1980s to the present and focuses on four debates. First, we evaluate the shift from an accounting-based view of debt sustainability using government borrowing rates to a model-based view that uses stochastic discount rates. Second, we review empirical tests, focusing on the relationship between primary balances and debt. Third, we discuss debt sustainability in the presence of rollover risk. And fourth, we evaluate whether government borrowing costs below rates of growth ( r < g) generate a free lunch, in the sense that debt sustainability does not require future primary surpluses. We argue that liquidity services provided by sovereign debt may indeed lead to a free lunch, albeit one of limited size. The value of such services depends on the credibility of the central bank, which can be accumulated via prudent policies and subsequently drawn on to allow for looser fiscal policy.

COORDINATION OF MONETARY AND FISCAL POLICIES DURING CRISIS

Abstract. The global crisis of 2020, caused by the spread of the COVID-19 coronavirus disease, has led to decline of the Ukrainian economy and contraction in the welfare of society. To overcome the effects of the crisis, the monetary and fiscal authorities have provided strong incentives, primarily to support the most vulnerable social groups and businesses most affected by quarantine restrictions, as well as to facilitate the financial stability of the banking sector. In conditions of limited government resources, to minimizing the negative effects of the crisis requires the highest efficiency of monetary and fiscal policies, which can only be achieved through proper coordination between monetary and fiscal authorities. The present article examines the peculiarities of the conduct and direction of monetary and fiscal policies before crisis processes arose in Ukraine and identifies the factors that constrain the effectiveness of both policies: shadow economy; permanent budget deficit; excessive public debt service costs; the dominance of non-monetary inflation factors in taking monetary policy decisions. Anti-crisis measures of monetary and fiscal authorities are described and analysed. It was determined that the stock exchange channel of money issuance stood inactive during the crisis, which led to a significant imbalance in the interest rate environment in Ukraine and to the increase in the cost of government borrowing in the domestic market, what was caused by poor coordination between monetary and fiscal policies. It has been established that the dominance of the state in the banking system of Ukraine has a negative impact on bank lending during the crisis, and the government’s program to stimulate lending restrains the reduction of interest rates on new loans through market mechanisms. To ensure post-crisis sustainable economic development, the following measures are advised: ensure a gradual reduction in public debt service costs; make the transition to a countercyclical fiscal policy, which will allow for an expansionary monetary policy; implement measures aimed at reducing the concentration of the state in the banking sector and endorse lending to the real sector of the economy rather than government, through state-owned banks; stimulating lending through monetary rather than fiscal mechanisms. Keywords: monetary policy, fiscal policy, monetary-fiscal policy coordination, economic development, central bank, corona crisis, Ukraine. JEL Classіfіcatіon E52, E62, E63, H12 Formulas: 0; fig.: 4; tabl.: 1; bibl.: 37.

НЕОБХІДНІ КРОКИ ДЛЯ РОЗВИТКУ ЕКОНОМІКИ ТА БАНКІВСЬКОГО СЕКТОРУ УКРАЇНИ В ПЕРІОД КОРОНАКРИЗИ ТА ПІСЛЯ ЇЇ ЗАВЕРШЕННЯ

Епідемія COVID-19 в Україні та світі зумовила вжиття державами безпрецедентних обмежувальних заходів з метою протидії поширенню вірусних захворювань і підтримки національних систем охорони здоров’я. Водночас запроваджені в Україні карантинні заходи, швидше, оголили та поглибили негативні тенденції в економіці, які спостерігаються з ІІ півріччя 2019 р. За дев’ять місяців 2020 р. падіння реального ВВП України становило 5,4%, а рівень споживчої інфляції протягом минулого року був нижче цільового діапазону НБУ, що свідчить про ознаки повноцінної стагнації у реальному секторі економіки.Ефективність функціонування інституту фінансового посередництва та механізму монетарної трансмісії в Україні залишається невисокою. Стагнація банківського кредитування триває третій рік поспіль, а застосовані НБУ заходи стимулювання економіки виявилися недостатньо продуктивними. Співвідношення між обсягом залучених банками депозитів та виданими кредитами з 2015 р. характеризується низхідним трендом.Ризик скорочення доходів державного бюджету України та підвищення вартості державних запозичень істотно ускладнює виконання державних програм з підтримки економіки. Відсутність достатнього простору для фінансування державних витрат за прийнятною вартістю ставить Україну в нерівні з країнами Центральної та Східної Європи умови в контексті подолання кризових явищ.З метою протидії кризі COVID-19 країни використовують поєднання державних фіскальних механізмів з монетарними і макропруденційними інструментами центральних банків. З огляду на ризик виникнення в Україні негативного циклу погіршення фінансового стану банківського та корпоративного секторів, обґрунтовано застосування комплексного підходу до вдосконалення державної економічної та фінансової політики, що дозволить отримати синергетичний ефект від здійснюваних заходів та забезпечити довгострокове стале зростання економіки України на базі ефективної кредитної підтримки банківської системи.

Forecast in detail

The adverse effect on the economy of continued restrictions on activity and extension of government Covid support schemes for households and firms mean projections for the fiscal deficit in 2020–21 have continued to climb. But the deficit should fall later back this year as activity recovers, while gilt purchases by the BoE should keep a lid on government borrowing costs.

Did profitable slave trading enable the expansion of empire?: The Asiento de Negros, the South Sea Company and the financial revolution in Great Britain

In 1711, British Parliament chartered the South Sea Company, a public–private corporation chartered to reduce the cost of government borrowing by swapping illiquid short-term government debt for tradeable shares of the South Sea Co. To attract subscribers, the government also awarded the South Sea Co. an international monopoly in the trade of African slaves to Spanish America—the Asiento de Negros. This paper considers the extent to which Asiento-related slave trading was profitable for South Sea Co. shareholders and beneficial to the British financial revolution between 1713 and 1743. First, we use historical financial data to estimate the parameters of a capital asset pricing model of excess returns for South Sea Co. shareholders. We find that the Asiento contract increased risk-adjusted excess returns on South Sea Co. stock between 18 and 24% per year. Second, we estimate profit margins in the South Sea Co. Asiento slave trade. These show a stark positive correlation with company share prices before and after the South Sea Bubble of 1720. Adding slave ship departures to the CAPM specifications confirms the direct contribution of slave trading to shareholder returns. We also find that the Asiento and Asiento-related slave trading increased central government fiscal surplus by 16%. This suggests that profitable slave trading by the South Sea Co. under the Asiento enhanced Great Britian’s fiscal capacity, which could be utilized to enhance a military capacity necessary for securing an empire.

The Driving Factors of EMU Government Bond Yields: The Role of Debt, Liquidity and Fiscal Councils

This study presents empirical evidence about the determinants of long-term government bond yields for 19 economies of the European Monetary Union (EMU) over the period 1995–2018 within a multivariate panel framework. The fixed effects estimators reveal that the relationship between public debt to the GDP ratio and yields is non-linear. We observe a threshold, which is determined to be at the area 90% of the ratio of public debt to GDP. Beyond that, area government borrowing costs increase as the public debt rises. Furthermore, we find evidence that a GDP decline and the downgrades of sovereign ratings increase the costs of government borrowing. In contrast, the operation of independent fiscal institutions helps to reduce government’s debt risk premium. Finally, liquidity in the Euro area plays a significant role on yields determination. The results remain robust when the dynamic instrumental variable fixed effect (FE-2SLS) and dynamic panel least square dummy variable corrected (LSDVC) estimators are employed. Empirical findings suggest important policy implications for the ongoing Covid-19 crisis for the EMU.

The Effect of Local Government Debt on Firm Leverage：Empirical Evidence from the City-level of China

Since 2008, the Global Financial Crisis has had a huge impact on China’s export-oriented economy. The State Council in 2008 launched an economic stimulus plan known as Four-Trillion Investment” （70.50% of the total package, i.e. 2.82 trillion RMB, was financed by local governments）. Since then, the scale of local government debt has increased significantly, which has produced some unexpected economic consequences for the allocation of credit resources and even economic development. The revenue and cost of government borrowing are the core concerns of many countries. The impact of government borrowing on the investment and financing of firms has been studied in the existing literature. Due to the great differences in the development of legal system and financial market, the micro consequences of government borrowing are also inconsistent, i.e. there is a dispute between the crowding-out effect” and the crowding-in effect” in the economic theory. Therefore, does local government debt affect the debt of local firms? If so, how does the affection occur? These are real problems worth studying. Based on the data of 266 cities in China, this paper tests the impact of the local government debt scale on local firms’ debt level and debt cost in 2008−2017. The results show that: First, the scale of local government debt decreases firm leverage. Specifically, the scale of local government debt decreases firm leverage by reducing the short-term debt and operating debt scale. Compared with state-owned, non-infrastructure and public welfare industries, and profitable companies, the scale of local government debt has a stronger negative effect on the firm leverage of non-state-owned, infrastructure and public welfare industries, and loss-making companies. Second, the scale of local government debt increases the debt cost of non-state-owned companies. The results show that the expansion of the local government debt scale has a crowding-out effect on firm leverage through the demand competition mechanism, and increases firms’ debt cost through the price mechanism. This paper contributes to the literature as follows: First, it not only tests the effect of local government debt on firm leverage, but also analyzes the way of local government debt affecting firm leverage. The results are helpful to enrich the literature of the impact of local government fiscal policies on micro enterprises. Second, different from the measurement of using federal or central government general debt, we measure the scale of local government debt based on city-level data, which is not only helpful to analyze the effect of government debt on firm behavior under the same institutional background, but also helpful to reduce the dependence on the time series model, make the data structure more matching, and make the research conclusion more robust. Third, we test the effect of government debt on firm leverage and debt cost from the perspective of the demand competition mechanism and price mechanism, which helps to reveal the causes of difficult and costly in financing” reflected by firms, and provide some decision reference for the central government in controlling the scale of local government debt, optimizing the allocation of credit capital, improving the financing ability of firms, and promoting economic development.

Do fiscal rules reduce government borrowing costs in developing countries?

AbstractWe examine whether adopting a numerical fiscal rule framework to guide fiscal policy helped reduce the cost of borrowing by governments in a sample of 61 low‐ and middle‐income countries for 1985–2017, 24 of which adopted such rules. We address the self‐selection problem of policy adoption by applying a variety of propensity score matching methods and show that the average treatment effect of fiscal rules on government borrowing costs is quantitatively quite large and statistically significant in rule adopting countries. We also find that the presence of institutional arrangements to strengthen fiscal rules results in a larger reduction in borrowing costs than is the case without these arrangements, which is consistent with strong rules adding to the credibility of the fiscal policy framework.

The 2017 Version of the IMF and World Bank's LIC Debt Sustainability Framework: 'Significant Overhaul' or Obsolete?

Public debt sustainability problems are widespread in Sub-Saharan Africa just 10 years after the Heavily Indebted Poor Countries-Multilateral Debt Relief Initiative (HIPC-MDRI) debt write-off. At the same time, public investment needs for the Sustainable Development Goals remain vast. The challenge is to reconcile debt sustainability and development in an environment of dwindling aid, worsening debt sustainability and a weak foundation for long run growth. Although billed a significant overhaul, the 2017 version of the Low-Income Country Debt Sustainability Framework (LIC DSF) is obsolete because it retains an antiquated focus on distress linked to the public and publicly guaranteed portion of external debt. A fundamental rethink rests on two planks. The first plank is a simplified DSF focusing on public debt, which recognizes that the marginal cost of government borrowing even among African Low-Income Countries, is now determined by the market, complemented by an assessment of international liquidity. The second plank is an acceptance by the IMF, the World Bank, the African Development Bank and donor community at large that the present system of aid allocation and policy dialogue is not delivering adequately, and needs to be reformulated. The paper discusses these topics and proposes a way forward, illustrated by Ethiopia.

The Impact of Government Borrowing Costs on Fiscal Discipline

SummaryThis paper studies the impact of government borrowing costs on fiscal discipline against the background of unprecedentedly low interest rates in advanced economies brought about by ultra‐expansionary monetary policies of recent years. Applying the panel data econometric approach for a sample of OECD and 11 early euro area countries over the period 1985–2015, the study suggests a positive and statistically significant impact of government borrowing costs on cyclically adjusted primary balances, indicating that a decrease in borrowing costs leads to a deterioration of fiscal policy stance. The findings herein also suggest that this effect in the euro area seems to be driven by a group of its peripheral rather than core countries and appears to work through the expenditure (more specifically, current expenditure) channel. From the economic policy perspective, these findings imply that monetary policy measures resulting in ultra‐low interest rates may cause negative side effects for fiscal discipline.

Fiscal Rules and Government Financing Costs

AbstractThis paper assesses the effect of fiscal rules on sovereign bond spreads over the short and medium term, for 34 advanced countries and 19 emerging market economies, over the period 1980–2016. Our results, based on impulse response functions, show that the dynamic impact of fiscal rules on sovereign yield spreads is negative and statistically significant, at around 1.2–1.8 percentage points, implying lower government borrowing costs. This result stems essentially from the advanced economies subsample. We also find that more fiscally responsible countries are the ones for which a fiscal rule reduces the government's borrowing costs. Moreover, in times of recession, a fiscal rule leads financial markets to reduce the risk premiums on government bonds. Finally, when it comes to design features of fiscal rules, independent monitoring of compliance to the rule, done outside government, also reduces sovereign spreads.

Može li uvođenje eura u Hrvatskoj sniziti trošak zaduživanja?

The paper analyses the impact of euro adoption on the reduction of borrowing costs of EU member states. The results of the analysis point to the existence of a "euro premium" – after controlling for the dynamics in the macroeconomic fundamentals of particular countries and the market sentiment, member states of the monetary union have, on average, lower borrowing costs and higher credit ratings than other EU member states. In order to draw attention to the significance that the results could have for bank interest rates in Croatia in the event of euro adoption, a simple VAR model is used to demonstrate that there is a statistically significant transmission of the changes in government borrowing costs to interest rates on bank loans.