Working Paper: The Impact of Sovereign Bond Yields on Fiscal Discipline

WP 5/2016

Abstract

This paper studies the impact of sovereign bond yields on fiscal discipline against the background of unprecedentedly low interest rates in advanced economies brought about by ultra-expansionary monetary policies of recent years. By employing the panel data econometric approach for a sample of OECD, EU and euro area countries over the period 1980–2014, the study suggests a positive and statistically significant impact of long-term sovereign bond yields on primary balances (PBs), indicating that a decrease in borrowing costs leads to a statistically significant deterioration of fiscal balances. The findings herein also suggest that falling bond yields pass on to fiscal balances through increases in government expenditure rather than revenue reduction. From the economic policy perspective, these findings imply that monetary policy measures resulting in ultra-low interest rates may cause negative side effects for fiscal discipline.

Keywords: fiscal policy, fiscal reaction function, sovereign bond yields, panel data

JEL codes: E62, H62