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A quest between fiscal and market discipline

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posted on 2022-12-02, 16:24 authored by Luca Agnello, Vitor CastroVitor Castro, Ricardo Sousa

Fiscal rules are typically seen as government constraints. Yet, the extent to which they are substituted or complemented by market discipline (especially, during financial stress) remains unexplored. Using data for 71 countries over the period 1985–2015, we estimate an “augmented” fiscal reaction function to assess the impact of both fiscal and market discipline. We find that different market signals influence fiscal policy, but fiscal discipline depends on market incentives. In the EU and the OECD, market signals complement fiscal rules. These are less effective in the EMU and non-OECD countries are “debt intolerant”. Yet, there are unintended consequences: (i) neither output and debt stabilisation, nor fiscal rules affect the fiscal stance in the absence of financial crises; and (ii) financial stress makes fiscal discipline a destabilising factor, while central bank actions almost dismiss it. Finally, market (fiscal) discipline effects are (not) persistent and stronger (more uncertain) for the EMU.

Funding

National Funds of the FCT – Portuguese Foundation for Science and Technology within the project “UID/ECO/03182/2020”

History

School

  • Business and Economics

Department

  • Economics

Published in

Economic Modelling

Volume

119

Publisher

Elsevier

Version

  • AM (Accepted Manuscript)

Rights holder

© Elsevier

Publisher statement

This paper was accepted for publication in the journal Economic Modelling and the definitive published version is available at https://doi.org/10.1016/j.econmod.2022.106119

Acceptance date

2022-11-21

Publication date

2022-11-26

Copyright date

2022

ISSN

0264-9993

Language

  • en

Depositor

Dr Vitor Castro. Deposit date: 24 November 2022

Article number

106119

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