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The international spillover of fiscal spending on financial variables

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Title: The international spillover of fiscal spending on financial variables


1
The international spillover of fiscal spending on
financialvariables
Isabel Vansteenkiste DNB/IMF workshop on
Preventing and Correcting Macroeconomic
Imbalances in the Euro Area, Amsterdam
14 October 2011
2
Outline
  • Introduction and review of the literature
  • The model
  • The data
  • The estimation results
  • 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
  • Conclusion

2
3
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
  • 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.
  • Analysis focussed on the earlier years of the
    monetary union.

3
4
Introduction and review of the literature
  • Our approach empirical GVAR model
  • 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
  • Country selection G7 (excl. Canada), Spain and
    Sweden.
  • Quarterly data 1980Q1-2008Q4

4
5
The model
  • GVAR akin to Dees, di Mauro, Pesaran and Smith
    (2007) and Pesaran, Schuermann and Weiner (2004)
  • Individual country-specific VECMs are estimated
    in which country-specific variables are related
    to corresponding country-specific weighted
    average of other countries variables
    deterministic variables

5
6
The data
  • Fiscal spending, real GDP, inflation, equity
    prices, government bond yields and corporate bond
    yields 1980Q1 to 2008Q4.
  • Real GDP/Inflation national sources
  • Fiscal spending national accounts real
    government spending (national sources)
  • Equity prices MSCI share price index with net
    dividend, in local currency (Haver Analytics)
  • Government bond yield 10-year benchmark yield
    (national central banks)
  • 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

6
7
The data
  • Correlation between each variable and
    country-specific foreign counterpart

7
8
Model testing
  • Integration properties of the series series I(1)
    with few exceptions
  • Rank of cointegration space (trace test
    statistics)
  • Japan, Sweden, UK 2 cointegrating relationships
  • Italy and Spain 3 cointegrating relationships
  • France, Germany and United States 4
    cointegrating relationships
  • Testing weak exogeneity of country specific
    foreign variables

8
9
Estimation results
  • Contemporaneous effects of country-specific
    foreign variables on their domestic counterparts

9
10
Estimation results
  • 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

10
11
Shock to government consumption impact on
government bond yields
  • Domestic bond yield response
  • Positive and statistically significant
  • Response grows and peaks after around 3-5
    quarters (except IT)
  • Largest response ES (20 bp), weakest response
    IT (8 bp)

11
12
Shock to government consumption impact on
government bond yields
  • Spillovers 2 distinct groups
  • 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
  • Impact positive and statistically significant
  • Fiscal spending shocks lead to an increase in
    global interest rates
  • Size 4 bp at peak
  • ES/IT Peripheral countries
  • Impact of a shock on DE/US/UK government bond
    yields negative and statistically significant (at
    peak 2-5 bps)
  • Impact on other peripheral countries government
    bond yields positive and statistically
    significant (at peak) 6-10 bps

12
13
Shock to government consumption impact on
government bond yields
  • Germany
  • United States

13
14
Shock to government consumption impact on
government bond yields
  • Italy
  • Spain

14
15
Shock to government bond yield impact on
corporate bond yield
  • Domestic corporate bond yield response
  • Positive and statistically significant
  • US/ES responses peaks instantaneously while in
    DE/IT it peaks after 2-8 quarters
  • Response ranges at peak between 13 and 49 bps

15
16
Shock to government bond yield impact on
corporate bond yield
  • Spillovers 2 distinct groups
  • 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
  • Impact positive and statistically significant
  • Instantaneous spillover of 10 bps
  • ES/IT Peripheral countries
  • Insignificant results for other countries

16
17
Shock to government bond yield impact on
corporate bond yield
  • Germany
  • United States

17
18
Shock to government bond yield impact on
corporate bond yield
  • Italy
  • Spain

18
19
Shock to government consumption impact on equity
prices
  • Theory/other empirical studies impact unclear
  • Keynesian effects could boost consumption/growth
    and created better earnings expectations
  • Government budget deficits may exert upward
    pressure on nominal interest rates and hence
    lower equity prices
  • Permanent substantial increases in government
    debt may signal unsound fiscal behaviour and
    lower equity prices

19
20
Shock to government consumption impact on equity
prices
  • 2 distinct groups
  • 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 US2.5 DE 4)
  • Spillovers positive but not statistically
    significant
  • ES/IT Peripheral countries
  • Domestic impact negative and statistically
    significant (at peak IT -1, ES-5)
  • Spillovers small and insignificant

20
21
Shock to government consumption impact on equity
prices
  • Germany
  • United States

21
22
Shock to government consumption impact on equity
prices
  • Italy
  • Spain

22
23
Conclusions
  • Empirical (non structural) approach to analyse
    the international spillover effects of fiscal
    shocks
  • Focus impact of fiscal spending shocks on
    financial variables
  • Methodology GVAR, 6 variables, 8 countries,
    1980Q1-2008Q4
  • Main findings
  • Fiscal policy of large countries with perceived
    risk free government bonds matter not only
    domestically but also internationally
  • 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
  • Importance of responsible policy conduct of safe
    haven (anchor) countries
  • Peripheral countries are punished for lax fiscal
    policy, moreover they punish other peripheral
    countries

23
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