Research

WORKING PAPERS:

”Fiscal Limits and the pricing of Eurobonds”, SSRN

Accepted at Management Science

with

This paper proposes a methodology to price bonds jointly issued by a group of countries—called Eurobonds in the euro-area context. We consider two types of bonds: the first is backed by several and joint (SJG) guarantees, the second features several but not joint (SNJG) guarantees. A crucial ingredient of the underlying pricing model is the fiscal limit, defined as the level of debt beyond which the risk of default is no longer zero. The pricing of the two types of Eurobonds reflects different assumptions regarding the pooling of the countries' fiscal resources and limits. We estimate fiscal limits for the four largest euro-area economies over 2008-2020 and deduce counterfactual Eurobond prices. Amid the euro-debt crisis, 5-year SNJG bond yield spreads would have been about twice larger than SJG ones. Hence, issuing SJG bonds would result in gains at the aggregate level. We finally show that (i) these gains can be shared among countries through post-issuance schemes so that all countries benefit from the issuance of SJG bonds, and that (ii) these redistribution schemes may alleviate the reduction in market discipline resulting from common bond issuances.

”Fiscal Limits and Sovereign Credit Spreads”, Proceedings of Paris December 2019 Finance Meeting EUROFIDAI - ESSEC

Submitted

with

Jean-Paul Renne (HEC Lausanne)

Exploiting information contained in the term-structure of sovereign credit spreads, we estimate time-varying fiscal limits – defined as the maximum outstanding debt that can credibly be covered by future primary budget surpluses. Our approach is based on a novel sovereign credit risk model accounting for the joint dynamics of debt, the fiscal limit, and bond prices. The empirical analysis is carried out on ten OECD economies, covering the period from 2007 to 2018. Our fiscal limit estimates feature substantial time-variation. In line with a wide range of empirical evidence, our framework captures the nonlinear sensitivities of credit spreads to fiscal conditions. We also obtain sizeable estimates of sovereign credit risk premiums – the components of sovereign spreads that would not exist if agents were risk-neutral.

(Codes available at https://github.com/jrenne/Fiscal-Limits-CDS )

”Fiscal Space and the size of the Fiscal Multiplier”, Bank of Italy Working Papers

with

Luca Metelli (Bank of Italy)

This paper investigates the interaction between fiscal policy transmission and fiscal sustainability, captured through the concept of fiscal space. In order to measure the evolution of fiscal space over time we propose four indicators, drawing from different concepts available in the literature. We use these indicators to define periods of ample and tight fiscal space. We then estimate the effects of government spending shocks in the United States according to the level of fiscal space, for the period 1929:Q1-2015:Q4. The main result of the paper is that fiscal multiplier is above one when fiscal space is ample, while it is below one when fiscal space is tight. Moreover, such difference is always significant. This result is very robust across different identification methods and samples.

POLICY WORK:

”Economic activity, fiscal space and types of COVID-19 containment measures”, IMF Working Papers

with

Amr Hosny (International Monetary Fund)

This paper examines the dynamic responses of economic activity and fiscal space (proxied by high-frequency daily data on NO2 emissions and CDS spreads, respectively) to various containment measures (physical closures and "smart" measures) using local projection à la Jorda (2005), including various state-dependency effects. We find evidence that tighter containment measures are associated with lower economic activity but also lower sovereign risk. We also construct a fiscal announcement dataset for Eurozone countries at “daily” frequency to help explain the transmission channels affecting CDS spreads following a containment measure shock.

WORK IN PROGRESS:

”Fiscal Consolidations in Good Times and in Bad”

This paper investigates the state-dependent effects of both tax- and expenditure-based fiscal consolidations via local projection methods à la Jordà (2005). The dataset employed includes 13 European countries covering the period 1978:Q1-2013:Q4. I employ the novel series of fiscal consolidation announcements constructed by Beetsma et al. (2021). Using the approach of Ramey and Zubairy (2018), I estimate cumulative output, consumption and investment multipliers. The main findings of the paper highlight that both the strength of the fiscal position and the constrainedness of monetary policy are crucial for the transmission of unanticipated fiscal consolidation shocks. Near the zero lower bound, an expenditure-based announcement of consolidation measures is contractionary differently from times where monetary policy is unconstrained. Tax-based consolidations are contractionary (non-recessionary) and expenditure-based ones are non-recessionary (expansionary) when the economy starts in a weak (strong) fiscal position. I also find that tax-based consolidations fail to stabilize debt, hinder consumer confidence and increase income inequality, while spending-based adjustments, in general, do not.