The weight of the median voter ageing on public debt

This paper studies the relationship between an ageing society and voter preference for financing public expenditures with debt versus income taxation. We focus on advanced economies and OECD members where ageing is relatively severe, the political process is more democratic, and economic institutions are subject to electorate scrutiny. Since there are no international data sources available for the median voter age, one of the contributions of this paper is the construction of a median voter series for the countries included in the study. The sample period covers 30 years, from 1980 to 2010. The panel estimates confirm the Brennan hypothesis (Const Polit Econ 23(3):182–198, 2012). A 1-year ageing of the median voter increases the public debt to GDP ratio by on the order of 4.5 percentage points.     

Budget Deficits and Redistributive Politics

This paper proposes a new view of the forces in the political process thatcause governments to accumulate debt. The analysis builds on a model of redistributive politics that, contrary to median voter models, does not restrict the set of policies that politicians can propose. I show that deficits occur even in an environment where voters (and periods) are homogeneous. This is an environment where previous political theories of debt would predict budget balance. In the model deficits are a way for candidates to better target promises to voters and are therefore used as tools of redistributive politics. The main contribution of the analysis is to show that the same forces that push candidates to redistribute resources across voters to pursue political advantage are forces that generate budget deficits.     

Sovereign debt, structural adjustment, and conditionality

The lack of a proper enforcement mechanism for sovereign debt generates a commitment failure. As a result, a sovereign may seek to improve its position in debt renegotiations and thus evade its debt obligations by reducing exports. Conditionality seeks to provide a solution to the incentive problem by addressing the commitment failure. Formalizing this argument, we show that conditionality helps the repayment of sovereign debt. In certain circumstances, it can eliminate debt overhang, especially when it is coupled with concessionary lending of sufficient magnitude. It is, however, unable to restore first best. When it is anticipated by lenders, conditionality may get international financial institutions and sovereign debtors into a trap where the debt overhang persist, debt rescheduling takes place periodically, and conditionality continues indefinitely.     

The sovereign spread in Asian emerging economies: The significance of external versus internal factors

This paper investigates the dynamic relations between external factors, domestic macroeconomic factors with sovereign spreads, debt to GDP ratio, etc. in Asian emerging countries. First, we develop a theoretical model that determines the equilibrium debt level, probability of default and sovereign spread and draw empirical implications. We then employ a Structural Vector Autoregression (SVAR) model to investigate empirically how the spread of sovereign debt is influenced over time by both external and domestic factors. The empirical results show that variations in sovereign spreads are mainly driven by external shocks, with the term structure of US interest rate and the global risk aversion having the most important role. The findings also indicate that shocks from the US have a direct effect on sovereign spread and an indirect effect via domestic macroeconomic fundamentals. Finally, the evidence produced validates the presence of some response patterns of sovereign spread to the external shocks.     

Sudden Stops,Time Inconsistency,and the Duration of Sovereign Debt

We study the sovereign debt duration chosen by the government in the context of a standard model of sovereign default. The government balances off increasing the duration of its debt to mitigate rollover risk and lowering duration to mitigate the debt dilution problem. We present two main results. First, when the government decides the debt duration on a sequential basis, sudden stop risk increases the average duration by 1 year. Second, we illustrate the time inconsistency problem in the choice of sovereign debt duration: governments would like to commit to a duration that is 1.7 years shorter than the one they choose when decisions are made sequentially.     

An Alternative Approach to the Institutional Economics of the Eurozone Crisis

I argue that the Eurozone crisis is neither a crisis of European sovereigns in the sense of governmental over-borrowing, nor a crisis of sovereign debt market over-lending. Rather, it is a function of the “sovereign debt market” institution itself. Crisis, I argue, is not an occurrence, but an element fulfilling a precise technical function within this institution. It ensures the possibility of designating — in the market’s day-to-day mechanisms rather than analytical hindsight — normal (tranquil, undisturbed) market functioning. To show this, I propose an alternative view on the institutional economics of sovereign debt markets. First, I engage literature on the emergent qualities of the institutions “market” and “firm” in product markets, concluding that the point of coalescence for markets is the approximation of an optimal observation of consumer tastes. I then examine the specific institution “financial markets,” where the optimal observation of economic fundamentals is decisive. For the specific sub-institution “sovereign debt market,” I conclude that the fundamentals in question — country fundamentals — oscillate between a status of observable fundamentals outside of markets and operationalized fundamentals influenced by market movements. This, in turn, allows me to argue that the specific case of the Eurozone crisis is due to neither of the two causes mentioned above. Rather, the notion of “crisis” takes on a technical sense within the market structure, guaranteeing the separation of herd behavior and isomorphic behavior on European sovereign debt markets. By the same token, the so-called Eurozone crisis ceases to be a crisis in the conventional sense.     

Evaluating sovereign risk spillovers on domestic banks during the European debt crisis

Using a Markov-switching model with time-varying probabilities, spillovers from sovereign to domestic bank CDS spreads during the European debt crisis for a set of 14 European countries and 30 European banks are investigated. Our model is able to capture how the increased sovereign risk observed between 2010 and 2013 throughout Europe has impacted i) the probability that banks fall into a crisis regime and ii) the probability that banks stay in the crisis regime. The latter state is characterized by a high volatility and large positive returns of CDS spreads. Different regime-dependent indicators have been computed to assess heterogeneity within the region. The evidence indicates that the intensification of sovereign risk observed during the European debt crisis has positively and significantly driven the regime shifts in volatility of the bank CDS spreads due to increased risk aversion. The results show that the increase in sovereign credit risk seems to have generated second-round effects for some banks that have experienced a deterioration in their funding conditions due to a rise in the domestic sovereign default risk. Overall, our results suggest that sovereign CDS spreads can be considered good forewarning indicators for predicting the evolution of bank CDS spreads. We also find that the effects differ depending on the country and the financial institution. This result suggests that banks are heterogeneously exposed to sovereign credit risk within the same country. One argument relates to the size of these financial institutions and the domestic exposure to sovereign debt.     

Redistribution,taxes, and the median voter

We study a simple model of production, accumulation, and redistribution, where agents are heterogeneous in their initial wealth, and a sequence of redistributive tax rates is voted upon. Though the policy is infinite-dimensional, we prove that a median voter theorem holds if households have identical, Gorman aggregable preferences; furthermore, the tax policy preferred by the median voter has the “bang-bang” property.     

Does local and Euro area sentiment matter for sovereign debt markets? Evidence from a bailout country

Does sentiment impact the sovereign debt markets? This article investigates whether lagged domestic and Euro area irrational sentiment (optimism or pessimism unwarranted by fundamentals) predicts future sovereign bond spreads, in Portugal, between January 2000 and December 2013. We find that domestic and Euro area sentiment negatively forecasts total return spreads and that this effect is stronger during the bailout period. Also, we find that the business sentiment is even most noticed. Therefore, Portuguese sovereign debt market is prone to the influence of investors’ sentiment.     

中国主权资产负债表及其风险评估(下)

2000——2010年,中国的国民资产负债表呈快速扩张之势。对外资产、基础设施以及房地产资产迅速积累,构成资产扩张的主导因素。这记载了出口导向发展战略之下中国工业化与城镇化加速发展的历史进程。在负债方,各级政府以及国有企业的负债以高于私人部门的增长率扩张。这凸显了政府主导经济活动的体制特征。对主权资产负债表的风险评估表明:(1)总体上,中国主权净值为正,因而,在相当一段时间内,发生主权债务危机的概率极低;(2)近期的风险点主要体现在房地产信贷与地方债务上,而中国的长期风险则更多集中在对外资产负债表、企业债务与社保欠账上。这些风险大都是或有负债风险,且与过去的发展方式密切相关;(3)主权债务动态的模拟进一步揭示出维持经济增长率与利率之差对于化解债务风险的重要性。因此,转变经济发展方式,保持经济可持续增长,是应对主权债务风险的根本途径。     

DO GOOD OR DO WELL? PUBLIC DEBT MANAGEMENT IN A TWO-PARTY ECONOMY*

Governments facing elections may strategically manipulate policy instruments in order to increase their re-election chances. The incentives for strategic manipulation are studied in the context of a debt management model, in which two parties with different inflation aversion compete in elections. It is shown that the inflation-averse party may issue nominal debt in order to make its opponent “look bad” to voters, thus getting closer to the median voter. Nominal debt artificially enlarges the ex-post inflation tax base, causing higher inflation. Conversely, an inflation-prone government may issue indexed debt in order to reduce inflation incentives.     

Investment Cycles and Sovereign Debt Overhang

We characterize optimal taxation of foreign capital and optimal sovereign debt policy in a small open economy where the government cannot commit to policy, seeks to insure a risk-averse domestic constituency, and is more impatient than the market. Optimal policy generates long-run cycles in both sovereign debt and foreign direct investment in an environment in which the first best capital stock is a constant. The expected tax on capital endogenously varies with the state of the economy, and investment is distorted by more in recessions than in booms, amplifying the effect of shocks. The government's lack of commitment induces a negative correlation between investment and the stock of government debt, a "debt overhang" effect. Debt relief is never Pareto improving and cannot affect the long-run level of investment. Furthermore, restricting the government to a balanced budget can eliminate the cyclical distortion of investment.     

Self-fulfilling crises with default and devaluation

We characterize optimal debt policy in a dynamic stochastic general equilibrium model of defaults and devaluations in which self-fulfilling crises can arise. When the government cannot commit to repay its debt and cannot commit to maintain the exchange rate, consumers’ expectations of devaluation make the safe level of government debt very low. We show that, when the debt is in the crises zone—where self-fulfilling crisis can occur—the government finds it optimal to reduce the debt to exit the zone. The lower the probability that consumers assign to devaluation, however, the greater is the number of periods that the government will choose to take to exit the crisis zone. We argue that our model can help understand events in Argentina in 2001–2002 and throw light on some aspects of the current EMU sovereign debt crisis.     

Local public expenditure in Sweden a model where the median voter is not necessarily decisive

This paper deals with local public expenditures, and the analysis is based on cross-section data for the Swedish municipalities. Two models are estimated; one is the basic median voter model where the decisive voter is assumed to be the voter with median income, while the other is a more general statistical alternative. The statistical alternative nests the basic median voter model as a special case, which makes it easy to test the null hypothesis that the basic median voter model is the correct model, given that the alternative is the true general structure. Although our results indicate a rejection of the null hypothesis, the estimation results are, nevertheless, similar for the two models.     

European policy and markets: Did policy initiatives stem the sovereign debt crisis in the euro area?

We investigate how European policy initiatives influenced market assessments of sovereign default risk and banking sector fragility during the sovereign debt crisis in four adversely affected countries — Portugal, Ireland, Spain and Italy. We focus on three broad groups of policies: (a) ECB policy actions (monetary and financial support), (b) EU programs (financial and fiscal rules as well as financial support in crisis countries), and (c) domestic austerity programs. We measure immediate market impact effects: what policies changed risk perceptions, using CDS spreads on sovereign bonds and banks in this assessment. We employ dynamic panel and event study methodologies in the empirical work. We find that a number of programs initially stabilized sovereign and bank bond markets (e.g. Outright Monetary Transactions program), although announcement and implementation impacts on markets differed in some cases (e.g. second Covered Market Bond Program). Actions designed to shore up sovereign markets often lowered risk assessments in bank bond markets and policies designed to ensure safety and soundness of the European banking system in some cases significantly impacted sovereign debt markets. Finally, a number of policies designed to stabilize markets had surprisingly little immediate impact on either sovereign or bank bond market risk assessments.     

Can fiscal rules improve financial market access for developing countries?

A number of countries have introduced fiscal rules to deter fiscal profligacy, enhance the credibility of fiscal policy, and reduce borrowing costs. In this paper, we examine the outcome of fiscal rules in terms of improving financial market access for developing countries. We use entropy balancing and various propensity score matching. We find that the adoption of fiscal rules reduces sovereign bond spreads and increases sovereign debt ratings for a sample of 36 developing countries, which are part of the JP Morgan Emerging Markets Bond Index Global (EMBIG), for the period 1993-2014. We explain this finding by the effect of fiscal rules on the credibility of a country's fiscal policy: more credible governments are rewarded in the international financial markets by low sovereign bond spreads and high sovereign debt ratings. These results are robust to a wide set of alternative specifications. We also show that this favorable effect is sensitive to several country structural characteristics. Our findings confirm that the adoption and sound implementation of fiscal rules is an instrument for policy makers to improve developing countries’ financial market access.     

Financial stress and sovereign debt composition

Using a panel of 13 advanced economies for the period 1980–2012, we find that periods of impaired financial intermediation mainly accrue to maturity mismatches in sovereign debt. Thus, a higher (lower) share of short-term (medium and long-term) debt leads to an increase in the financial stress index. From a policy perspective, our work suggests that debt management policies translated into longer average maturities of sovereign debt not only reduce the expected debt servicing cost, but also mitigate strains in the financial sector.     

Sovereign debt and the length of economic depressions

We analyze the duration of economic depressions to see if there is an association with consecutive years of high public-debt-to-GDP ratios. We find that there is a positive, non-linear association between the sovereign debt ratio and the length of depressions. Inflation is negatively and linearly correlated with depression duration. These associations are robust to the inclusion of controls for development, but we do detect cross-country heterogeneity in the probability of exit. An analysis of causality finds little evidence that high levels of sovereign debt cause depressions to be longer. Rather, it appears that longer depressions elicit higher debt relative to GDP. Public deleveraging during a depression is not likely, therefore, to help bring it to an end.     

Model uncertainty in Panel Vector Autoregressive models

We develop methods for Bayesian model averaging (BMA) or selection (BMS) in Panel Vector Autoregressions (PVARs). Our approach allows us to select between or average over all possible combinations of restricted PVARs where the restrictions involve interdependencies between and heterogeneities across cross-sectional units. The resulting BMA framework can find a parsimonious PVAR specification, thus dealing with overparameterization concerns. We use these methods in an application involving the euro area sovereign debt crisis and show that our methods perform better than alternatives. Our findings contradict a simple view of the sovereign debt crisis which divides the euro zone into groups of core and peripheral countries and worries about financial contagion within the latter group.     

Fundamentals and Sovereign Risk of Emerging Markets

We empirically assess the relative importance of various economic fundamentals in accounting for the sovereign credit default swap (CDS) spreads of emerging markets during 2004–2012, which encompasses the global financial crisis of 2008–2009. Inflation, state fragility, external debt and commodity terms of trade volatility were positively associated, while trade openness and a more favourable fiscal balance/GDP ratio were negatively associated with sovereign CDS spreads. Yet the relative importance of economic fundamentals in the pricing of sovereign risk varies over time. The key factors are trade openness and state fragility in the pre‐crisis period, the external debt/GDP ratio and inflation in the crisis period, and inflation and the public debt/GDP ratio in the post‐crisis period. Asian countries enjoy lower sovereign spreads than Latin American countries, and this gap widened during and after the crisis. Trade openness was the biggest factor behind Asia's lower sovereign spreads before the crisis, and inflation during and after the crisis. The results imply that external factors were paramount in pricing sovereign risk prior to the crisis, but internal factors associated with the capacity to adjust to adverse shocks gained prominence during and after the crisis.