Transcript Slide 1

The international spillover of fiscal
spending on financial
variables
Isabel Vansteenkiste
DNB/IMF workshop on Preventing and Correcting
Macroeconomic Imbalances in the Euro Area, Amsterdam
14 October 2011
Outline
1.
Introduction and review of the literature
2.
The model
3.
The data
4.
The estimation results
a) The impact of a shock to government consumption on government
bond yields
b) The impact of a shock to government bond yields on corporate
bond yields
c)
4.
The impact of a shocks to government consumption on equity
prices
Conclusion
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Introduction and review of the literature
•
Potential spillovers from fiscal expansion and exit strategies are high on the
agenda of international policy discussions
•
Theoretical literature: domestic fiscal policy can have international
implications, however final effect unclear
•

2 country Mundell-Fleming framework: debt financed spending bids
interest rate up
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Frenkel and Razin (1992): introduction of intertemp. budget constraint and
gov. spending entering the utility function separably, interest rate movement
depends on marginal savings propensity of domestic and foreign agents.
Empirical literature: few studies

Main focus on the real side international implications of fiscal spending
shocks.
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Analysis focussed on the earlier years of the monetary union.
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Introduction and review of the literature
•
Our approach: empirical GVAR model
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Expand the time variables of interest, country scope and time span

Six variables: fiscal spending, real GDP, inflation, equity prices,
government bond yields and corporate bond yields
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Country selection: G7 (excl. Canada), Spain and Sweden.
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Quarterly data: 1980Q1-2008Q4
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The model
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GVAR akin to Dees, di Mauro, Pesaran and Smith (2007) and Pesaran,
Schuermann and Weiner (2004)
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Individual country-specific VECMs are estimated in which countryspecific variables are related to corresponding country-specific
weighted average of other countries’ variables + deterministic
variables
xi,t  ai,0  ai,1t  i xi,t 1   i,0 xi*,t   i,1xi*,t 1  i,0dt  i,1dt 1   i,t
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The data
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Fiscal spending, real GDP, inflation, equity prices, government bond
yields and corporate bond yields – 1980Q1 to 2008Q4.

Real GDP/Inflation: national sources
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Fiscal spending: national accounts real government spending
(national sources)
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Equity prices: MSCI share price index with net dividend, in local
currency (Haver Analytics)
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Government bond yield: 10-year benchmark yield (national
central banks)
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Corporate bond yield: Long term corporate bond yield of
investment grade corporates (AAA to BBB) (global financial
database)
Foreign variables weighted using trade weights (export plus import)
for period 2000-2008 from IMF DOTS
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The data
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Correlation between each variable and country-specific foreign
counterpart:
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Model testing
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Integration properties of the series: series I(1) with few exceptions
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Rank of cointegration space (trace test statistics):
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Japan, Sweden, UK: 2 cointegrating relationships
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Italy and Spain: 3 cointegrating relationships
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France, Germany and United States: 4 cointegrating relationships
Testing weak exogeneity of country specific foreign variables
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Estimation results
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Contemporaneous effects of country-specific foreign variables on their
domestic counterparts
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Estimation results
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Generalised impulse response functions (Pesaran and Shin, 1998)

The impact of a shock to government consumption on government
bond yields

The impact of a shock to government bond yields on corporate
bond yields

The impact of a shocks to government consumption on equity
prices
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Shock to government consumption: impact on government bond yields
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Domestic bond yield response
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Positive and statistically significant
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Response grows and peaks after around 3-5 quarters (except IT)
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Largest response: ES (20 bp), weakest response: IT (8 bp)
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Shock to government consumption: impact on government bond yields
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Spillovers – 2 distinct groups

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US/DE/UK: countries with a large, liquid financial sector and
fiscal policy perceived to be sustainable (over sample period) →
risk free government bond market
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Impact positive and statistically significant
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Fiscal spending shocks lead to an increase in global interest
rates
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Size: 4 bp at peak
ES/IT: Peripheral countries
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Impact of a shock on DE/US/UK government bond yields
negative and statistically significant (at peak 2-5 bps)
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Impact on other peripheral countries government bond yields
positive and statistically significant (at peak) 6-10 bps
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Shock to government consumption: impact on government bond yields
•
Germany
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United States
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Shock to government consumption: impact on government bond yields
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Italy
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Spain
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Shock to government bond yield: impact on corporate bond yield
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Domestic corporate bond yield response

Positive and statistically significant
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US/ES: responses peaks instantaneously while in DE/IT it peaks
after 2-8 quarters
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Response ranges at peak between 13 and 49 bps
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Shock to government bond yield: impact on corporate bond yield
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Spillovers – 2 distinct groups

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US/DE/UK: countries with a large, liquid financial sector and
fiscal policy perceived to be sustainable (over sample period) →
risk free government bond market
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Impact positive and statistically significant
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Instantaneous spillover of 10 bps
ES/IT: Peripheral countries
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Insignificant results for other countries
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Shock to government bond yield: impact on corporate bond yield
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Germany
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United States
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Shock to government bond yield: impact on corporate bond yield
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Italy
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Spain
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Shock to government consumption: impact on equity prices
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Theory/other empirical studies: impact unclear
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Keynesian effects could boost consumption/growth and created
better earnings expectations
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Government budget deficits may exert upward pressure on
nominal interest rates and hence lower equity prices
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Permanent substantial increases in government debt may signal
unsound fiscal behaviour and lower equity prices
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Shock to government consumption: impact on equity prices
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2 distinct groups
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US/DE/UK: countries with a large, liquid financial sector and
fiscal policy perceived to be sustainable (over sample period) →
risk free government bond market

Domestic impact positive and statistically significant (at peak
US:+2.5%; DE: +4%)
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Spillovers positive but not statistically significant
ES/IT: Peripheral countries
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Domestic impact negative and statistically significant (at peak
IT: -1%, ES:-5%)
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Spillovers small and insignificant
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Shock to government consumption: impact on equity prices
•
Germany
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United States
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Shock to government consumption: impact on equity prices
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Italy
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Spain
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Conclusions
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Empirical (non structural) approach to analyse the international
spillover effects of fiscal shocks
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Focus: impact of fiscal spending shocks on financial variables
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Methodology: GVAR, 6 variables, 8 countries, 1980Q1-2008Q4
Main findings
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Fiscal policy of large countries with perceived risk free government
bonds matter not only domestically but also internationally
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Safe haven countries benefit from lax fiscal policies in other
countries since their government and corporate bond yields go
down while equity prices go up
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Importance of responsible policy conduct of safe haven (anchor)
countries
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Peripheral countries are punished for lax fiscal policy, moreover
they punish other peripheral countries
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