Fiscal variables and bond spreads – evidence from Eastern European countries and Turkey

Abstract

We investigate the impact of fiscal variables on bond yield spreads relative to US Treasury bonds in the Czech Republic, Hungary, Poland, Russia and Turkey from May 1998 to December 2007. To account for the importance of market expectations we use projected values for fiscal and macroeconomic variables generated from Consensus Economics Forecasts. Moreover, we compare results from panel regressions with those from country (seemingly unrelated regression) estimates. We find that, contrary to the evidence suggested by panel estimations, the role of the individual explanatory variables, including the importance of fiscal variables, varies significantly across countries when using the SUR specification.

Keywords:

• budget deficits
• determination of interest rates
• fiscal policy
• Eastern European countries

JEL Classification:

• C33
• E43
• E62
• H62

Notes

¹ Baldacci et al. (2008) provide a survey of the literature and find a stronger result regarding fiscal deficits when excluding public debt from the regression.

² Consensus Economics conducts the survey during the first week of each month and publishes the forecasts at the beginning of the second week of the respective month. Its participants are professional economists working for universities and financial institutions such as international economic research institutes, investment and commercial banks. The number of participants varies from country to country with Poland having the highest number of forecasters (36) and Hungary the lowest (29). Further information can be found in the website: www.consensuseconomics.com.

³ The forecasts provided for the current year exhibit on average a 6-month forecast horizon (average between the 12-month forecast horizon of January and 1-month horizon of December). Likewise, forecasts for the next year have on average a forecast-horizon of 18 months.

⁴ A complete list of all participants is available upon request. Note that the survey participants are not necessarily engaged in trading in the bond market.

⁵ Batchelor (2001) and Blix et al. (2001) show that Consensus Economics forecasts are less biased and more accurate in terms of mean absolute error and root mean square error compared to OECD and International Monetary Fund (IMF) forecasts. They also show that there is little information in the OECD and IMF forecasts that could be used to reduce significantly the error in the private sector forecasts. On top of that, Dovern and Weisser (2010) provide evidence that the participants in the Consensus poll provide rational and unbiased inflation and growth forecasts for the G7 countries.

⁶ For evidence on herding behaviour among market participants see Trueman (1994).

⁷ Allers et al. (1998) also use survey data to analyse expectations on fiscal variables. They conduct a survey with newspaper readers in the Netherlands on their knowledge of government indebtedness and behaviour in response to the fiscal policy stance. They find no significant evidence of Ricardian equivalence on their sample.

⁸ Though the sample only runs until December 2007, our results are robust for other sample periods. For instance, analysing the period after the euro introduction yields qualitatively similar results which are available upon request.

⁹ See Heppke-Falk and Hüfner (2004) and Beck (2001). A constant forecast horizon is crucial since the forecast performance improves with a shortening of the forecast horizon.

¹⁰ The mathematical derivation of Equation 1 is available upon request.

¹¹ As we refer to the medium-term analysis this averaging should diminish disturbances arising from potential market overreactions due to short-lived political news.

¹² We use US dollar denominated bonds since data on euro denominated bonds is not available for the full sample period.

¹³ According to standard tests shown in the Appendix all variables are panel stationary.

¹⁴ The results do not change qualitatively if we take the median or modus into consideration. Results are available upon request.

¹⁵ However, considering the time period before and after the decision on the EU membership does not change our results qualitatively. The results are available upon request.

¹⁶ For a definition of external debt we refer to WEO (2003).

¹⁷ See Judson and Owen (1999).