The inaugural Fiscal Policy Seminar took place at the German Finance Ministry in Berlin on 13 and 14 December 2018. Entitled “Rethinking Market Discipline”, the two-day event brought together highly respected experts from academia, central banks and government ministries to discuss the role that well-functioning and stable financial markets play in fostering sound fiscal policies. The seminar placed a spotlight on key issues such as the creation of international insolvency procedures for sovereign states; spillover effects in monetary unions; and false incentives at the institutional level. It also focused on specific cases such as the debt crisis in Puerto Rico. The seminar was attended by 54 participants from 14 different countries. A call for research papers was released prior to the event. After receiving a large number of quality submissions, an independent scientific committee selected eight papers to be presented and discussed at the Fiscal Policy Seminar. The scientific committee was headed by Andreas Peichl (ifo Institute, LMU Munich), supported by Ronald B. Davies (University College, Dublin), Essi Earola (VATT Institute for Economic Research, Helsinki) and Aitor Erce (European Stability Mechanism, Luxembourg).
On the first day of the seminar, discussions focused on insolvency procedures for sovereign states. In their study on the 2017 Puerto Rican debt crisis, Robert Chirinko (University of Illinois at Chicago) and his co-authors demonstrated that, despite poor macroeconomic fundamentals, the expectation of a government bail-out had kept interest on Puerto Rican government bonds low for a sustained period of time. It was only after the precedent set by the city of Detroit’s 2013 bankruptcy that Puerto Rico saw a substantial interest rate increase of 4 percentage points. As a result, it was no longer able to service its debt. The authors came to the conclusion that, in the case of Puerto Rico, false expectations of a rescue on the financial markets led to a delayed market reaction. This also delayed bankruptcy. The presentation was followed by a debate about possible ways of lowering financial markets’ expectations of a rescue of euro area member states. The question of whether the European Central Bank (ECB) should move away from its promise to act as the saviour of last resort on the financial markets (“whatever it takes”) was the subject of especially heated debate.
In their empirical study, Chuck Fang (Wharton Business School) and his co-authors examined how government bonds need to be structured to ensure that, in the event of default, a large number of investors agree to the restructuring of government debt. With the help of a data set that was especially created for this study, the authors were able to show that only Collective Action Clauses (CACs) with single-limb aggregation are effective in preventing free-rider behaviour on the part of investors. They allow investors to vote collectively on restructuring for all bond issues, with a qualified majority sufficient for a decision that is then binding on all bondholders. There was broad consensus about the benefits of CACs with single-limb aggregation.
Collective Action Clauses (CACs) are clauses that are written into the terms and conditions of government bonds. They allow individual terms, such as those governing repayment, to be changed with the approval of a predefined percentage of bondholders. If this threshold is reached, the agreed change is binding on all holders of the bond. Such clauses can be used to reschedule or restructure debt by agreement between the bondholders and the issuer.
allows for a single vote by the holders of all the bonds issued by one debtor. There is no second vote in each bond series, as is currently the case in euro area CACs, for example. If the approval threshold is reached, the decision is binding on the holders of all affected bonds of the issuer in question.
Pablo Burriel (Banco de España) and his co-authors used a New Keynesian general equilibrium model for the euro area member states to show that the positive effects of fiscal consolidation increase if risk premiums on government bonds are based on debt sustainability. Countries with impaired debt sustainability and high debt levels benefit disproportionately from lower risk premiums following fiscal consolidation. This means that successful consolidation policies are especially effective in reducing interest rates and boosting growth in highly indebted euro area countries.
Friedrich Heinemann (University of Heidelberg, ZEW) presented a political-economic model that helps to explain the discrepancy between the interests of academics and politicians when it comes to reforms aimed at restructuring public debt. He classified the different attitudes to reform proposals (debt restructuring, fiscal transfers) on the part of the most important political actors (European Commission, European Central Bank, European Parliament, EU member states with high and low debt levels) and demonstrated that the interests of the various actors are in conflict with each other. As a possible compromise, he proposed political measures that he termed “hidden transfers”, such as lending by the European Stability Mechanism (ESM) with low interest rates and long maturities. In the subsequent debate, some participants rejected the term “hidden transfers” for the ESM’s publicly communicated actions.
On the second day of the conference, discussions focussed on the interaction between the institutional framework, fiscal policy and market participants. Michael Weber (University of Chicago) and his co-authors studied the effect of expected inflation on consumer behaviour. To measure this, the authors evaluated a GfK survey on consumer expectations before and after Germany’s 2007 VAT increase was announced. They found that the announced tax increase raised inflation expectations, and that households brought forward the purchase of consumer durables in anticipation of higher prices. The authors concluded that announcements of future tax increases could be used as an unconventional fiscal policy instrument in crises. However, since households experience greater budget restrictions in times of crisis (including poorer access to credit), the ensuing debate cast doubt on the applicability of such measures.
Nils Wehrhöfer (University of Mannheim) and his co-authors investigated the distributional effects of fiscal consolidation imposed by fiscal rules in Italian municipalities, which levy surcharges on income tax. After the introduction of debt-based fiscal rules, taxes on middle and high incomes increased. Municipal expenditure did not fall in any significant way. In the subsequent discussion, participants questioned the extent to which empirical findings from Italian municipalities could be generalised and fiscal policy conclusions drawn.
A team of researchers led by Roel Beetsma (University of Amsterdam) presented a fiscal transfer system between euro area countries based on sectoral weighting of national exports. If world trade collapsed in a given sector, member states with a comparatively high share of exports in that sector would receive transfers. The system’s orientation towards world trade is designed to ensure that transfers would be paid only in the event of exogenous and asymmetric economic shocks – in other words, they would be independent of political influence. This is intended to reduce false incentives for national governments as well as deadweight effects. A point of criticism raised in the ensuing discussion was that the proposed approach would hedge risks in export-oriented member states. In addition, it was pointed out that such an insurance approach could ultimately create equally false economic policy incentives in the member states, as they might be tempted to place too low a priority on a broad and diversified export economy.
Presentation of the Best Paper Award
The Best Paper Award, with prize money of €5,000, went to the paper “Market discipline: Sovereign spread shocks and macroeconomic performance” by Benjamin Born, Gernot J. Müller, Johannes Pfeifer and Susanne Wellmann. The researchers showed that financial markets can impose discipline on governments. In the award assessment of the independent scientific committee, Andreas Peichl praised the paper as a successful analysis of the interplay between fiscal policy and financial markets. Torsten Arnswald, head of the German Finance Ministry’s Fiscal Policy Division, congratulated the winners on behalf of the Ministry and thanked all participants for their contribution to the seminar’s success.
Best Paper Award
“Market discipline: Sovereign spread shocks and macroeconomic performance”
Benjamin Born (Frankfurt School of Finance and Management), Gernot J. Müller (University of Tübingen), Johannes Pfeifer (University of Cologne), Susanne Wellmann (University of Tübingen)
- Research questions: How do rising sovereign spreads impact economic growth? Do such rises enhance fiscal policy discipline?
- In their empirical study, the authors use country data from 38 advanced and emerging economies. Their data set dates back to the early 1990s and includes economic, fiscal and socio-economic data.
- The results show that financial markets can impose discipline on governments by creating incentives for fiscal consolidation and sustainable budget policies.
- Sovereign spread increases result in lower public spending and lower economic growth. Countries with high levels of debt also record a significant increase in tax revenue.
Using large data sets for a large number of countries, the research provides clear empirical evidence that financial markets exert a considerable disciplining influence on fiscal policy.
Table 1 lists all the presentations given at the seminar. Many of the papers can be found on the authors’ websites; others have not yet been finalised and are therefore not available.
The inaugural Fiscal Policy Seminar provided new input and ideas for the German Finance Ministry’s work. The aim of the seminar was to establish a productive debate about innovative ideas and strategies between fiscal policy-makers and researchers in the field of finance. The seminar succeeded in achieving this.
Attendance was good, and the debates were lively and open. A great deal of positive feedback was received after the event, reflecting the seminar’s value for international participants, as well. The German Ministry of Finance plans to organise another Fiscal Policy Seminar this year, most likely in autumn.