Sub-nationals' risk premia in fiscal federations: Fiscal performance and institutional design

Sergio Sola and Geremia Palomba

Journal of International Money and Finance, 2016, vol. 63, issue C, 165-187

Abstract: The recent debt crisis in Europe highlighted the importance of institutional design and, in particular, bail-out clauses in determining States' risk premia in fiscal or quasi-fiscal federations. This paper examines the determinants of sub-national governments' risk premia in fiscal federations using secondary market data for the USA, Canada, Australia and Germany. It finds that, as for central governments, fiscal fundamentals matter in the pricing of risk, and sub-national governments with higher public debt and larger deficits pay higher premia. However, this relationship is not uniform across federations and it differs with institutional arrangements. In particular, market pricing mechanisms are less effective in presence of explicit or implicit guarantees from the central government. We show that when sub-national governments depend on high transfers from the central government (i.e., when there is some form of implicit guarantee from the center), markets are less responsive to sub-national governments' fiscal fundamentals. Using primary market data, the paper also shows that high transfer dependency lowers the probability of sub-national governments to borrow on capital markets.

Keywords: Sub-national governments; Fiscal policy; Interest rates; Risk premia; Government debt; Fiscal federations (search for similar items in EconPapers)
JEL-codes: E44 E62 G12 H6 H7 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:63:y:2016:i:c:p:165-187

DOI: 10.1016/j.jimonfin.2016.01.009

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