A Political Economy of Fiscal Space: Political Structures, Bond Markets, and Monetary Accommodation of Government Spending Potential in the Core and Periphery

ABSTRACT

In times of economic crisis, academics, policy-makers, and pundits often debate the correct level and best use of government debt. This paper argues structural political and economic factors grant core economies more fiscal space than peripheral economies. While the federal governments of the US, Germany, and other core economies may easily issue and sell debt in private markets, smaller economies, both municipalities within countries, and countries in the global periphery, are more vulnerable to demand fluctuations. All economies may benefit from explicit commitments by monetary authorities to resume their historic roles as governments’ banks, especially during crises. By highlighting present political constraints, monetary structures, and market factors that may inhibit governments’ successful placement of bonds, this paper deepens present debate about the potential feasibility of functional finance to facilitate fiscal activity, even in unprecedented times.

KEYWORDS:

• Sovereign debt
• government
• monetary authorities
• monetary policy
• fiscal policy

JEL CODES:

• E12
• E62
• E42
• E58
• G31
• H63

Acknowledgements

I gratefully acknowledge the feedback from two anonymous reviewers. I would also like to thank Carolyn Abott for organizing this special issue, the organizers and participants in the SSIREP research workshop in November 2021; Tai Young-Taft, Harold Hastings, and attendees of the ICAPE keynote address in 2022, and Charlotte Rommerskirchen who all provided feedback on earlier versions of this text. All errors remain my own. Finally, thanks to Johann Patlak, Andrew Roos, and every other nonacademic friend that has asked me if there is any level of government debt that I might consider to be ‘too high’

Disclosure Statement

No potential conflict of interest was reported by the author(s).

Notes

1 While this paper tends to use the terms ‘core’ and ‘periphery’ interchangeably with ‘high-income’ or ‘large’ and ‘low-income’ or ‘small,’ regions of the world considered ‘developed’ or ‘emerging’ may have their own cores and peripheries (Wallerstein 2004). Though European economies have higher GDPs than many emerging market economies, smaller European economies may follow more peripheral dynamics compared higher-income economies, as during the Eurozone crisis.

2 Data accessed for this part of the paper is from the OECD’s statistics site, https://stats.oecd.org/, in October 2021, with specific focus on national accounts.

3 This paper discusses developments in fiscal rules since the pandemic in the fourth section.

4 This paper later discusses ECB measures to backstop European sovereign debt. However, such policy violated European law, and was challenged unsuccessfully by the German court in 2020.

5 This sample of economies was chosen on the basis of reliable data for both long-term sovereign bond rates and government debt levels over the period 2000 through 2022.