A “Beggar-Thy-Neighbor” Effect in Public Debts? Evidence from Cross-Border Spillovers of Fiscal Consolidations /

In a globalized world, countries are exposed to policy shocks from abroad. This paper investigates the cross-border effect of fiscal consolidations taking place in two safe assets countries (Germany and the USA). Cross-border spillovers are defined as the results of fiscal consolidation shocks in Germany or USA which are transmitted to peripheral countries. We consider two levels of analysis: the external effect of US fiscal consolidations on other OECD countries and the external effect of German fiscal consolidations on other Eurozone countries. The “beggar-thy-neighbor” effect in this context means that a reduction of the public debt in a safe asset country as a consequence of a fiscal consolidation plan may generate an increase in the public debt abroad. We suggest a financial market mechanism composed by two steps. First, a fiscal consolidation by reducing government bond issuance in the safe asset countries may generate an excess of demand in the financial market which may then reduce the borrowing cost faced by the peripheral countries. Second, this reduction in the borrowing cost leads to an increase in government bond issuance of the peripheral countries. Our empirical analysis in a sample of 27 OECD countries over the period 1980 - 2007 shows an evidence of a “beggar-thy-neighbor” effect in public debts. We find empirical supports for the mechanism both at the OECD and the Eurozone levels.