Public Debt in Advanced Economies and its Spillover Effects on Long-term Yields

C. Emre Alper, Lorenzo Forni
2011 IMF Working Papers  
The possibility that fiscal policy may have non-Keynesian effects, and in particular the idea that fiscal consolidation can be expansionary even in the short run, has stimulated interest among academic economists and policymakers since at least the early 1990s. The sovereign debt crises that have been haunting Europe since early 2010 have brought this subject to the fore of the debate on fiscal policy once again. Recent studies have re-examined the empirical evidence for expansionary fiscal
more » ... ractions. Policymakers, particularly in Europe, are having to delicately balance the need to reassure the financial markets and credit rating agencies against the danger of jeopardizing the fragile recovery of their economies or of pushing their economies further into recession. Achieving and maintaining a sustainable level of public debt over the medium term will require a major and sustained fiscal adjustment in most advanced Following the recent financial crisis and the associated rise in the already high levels of public debt, concerns for fiscal sustainability remain elevated in many advanced economies. This article analyzes the likely effect of the high and rising government debt of large advanced economies (AEs) on the borrowing rates of small open economies, as well as most of the emerging market economies (EMEs). The results indicate that beyond a threshold, a rise in public debt ratio in large AEs increases the long-term rates in EMEs and that depending on the level of public debt in AEs, this effect could be large. There is a vast literature analyzing the impact of debt-financed fiscal expansion on domestic long-term real yields. The theoretical foundations for such an effect are well known. Fiscal expansion, even a temporary one, will lead to a permanent (continued on page 4)
doi:10.5089/9781463902209.001 fatcat:awh2ia3ekrclzi3lwectq4e6y4