Fiscal policy and interest rates the role of financial and.pdf

Research Institute of Applied Economics 2008 Working Papers 2008/ 10, 29 pages Fiscal policy and interest rates: the role of financial and economic integration* By Peter Claeys, Rosina Moreno and Jordi Suriñach AQR Research Group - IREA. Department of Econometrics, University of Barcelona. Avda. Diagonal, 690. 08034 Barcelona, Spain. Email: Peter.Claeys@ub.edu. Abstract: It is commonly believed that a fiscal expansion raises interest rates. However, these crowding out effects of deficits have been found to be small or non-existent. One explanation is that financial integration offsets interest rate differentials on globalised bond markets. This paper measures the degree of integration of government bond markets, using spatial modelling techniques to take this spillover on financial markets into account. Our main finding is that the crowding out effect on domestic interest rates is significant, but is reduced by spillover across borders. This spillover is important in major crises or in periods of coordinated policy actions. This result is generally robust to various measures of cross-country linkages. We find spillover to be much stronger among EU countries. Key words: fiscal policy,