Government borrowing cost and budget deficits: is investment spending different?

Jemima Peppel-Srebrny

No 827, Economics Series Working Papers from University of Oxford, Department of Economics

Abstract: We find that bond markets charge significantly higher interest rates for deficits due to higher government current spending than for deficits due to higher government investment. Thus, from a sovereign risk perspective, not all government budget deficits are created equal. To show this, we use a panel regression approach on European Commission data for 31 advanced economies from 1990 onwards. Econometrically, we address potential endogeneity by using forecasts of fiscal variables and by instrumental variable methods. Based on our preferred specifications, a higher deficit solely due to higher government investment would in fact decrease long-term government bond yields. These findings suggest that the policy debate about fiscal sustainability and fiscal rules should, at the very least, distinguish budget deficits that are the result of investment from those that are not. Revised September 2020

Keywords: Government budget deficits; government investment; fiscal policy; long-term interest rates; OECD countries (search for similar items in EconPapers)
JEL-codes: E44 E62 H54 H62 (search for similar items in EconPapers)
Date: 2020-10-20
New Economics Papers: this item is included in nep-eec and nep-mac
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Citations: View citations in EconPapers (2)

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Journal Article: Not all government budget deficits are created equal: Evidence from advanced economies' sovereign bond markets (2021)
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