Role of institutions in fiscal performance

This dissertation examines the role of institutional features on fiscal outcomes: the level of hidden liabilities, credit spreads, and official government debt. We construct a country panel dataset and use quantile regression and error correction models for empirical analysis: quantile regression to verify how variables play different roles in explaining the level of hidden debt and credit spreads at each percentile of the conditional distribution and error correction model to investigate the role of institutional features on the long-term equilibrium level of government debt. In Chapter 1, we discuss the roles of credibility and fiscal discipline on the level of government debt. Our findings are as follows: First, the bond issuance ceiling expands as a country builds up credibility because higher credibility reduces the concerns over repudiation of existing debt. Governments with weak policymaking institutions may want to fully utilize this favorable funding condition and end up with a relatively high level of government debt. Next, once a government reaches a sufficiently high level of credibility, the optimal choice of government debt becomes smaller because stronger fiscal institutions induce the government to borrow less. In Chapter 2, we study which factors determine the government’s tendency to resort to off-budget activities. First, factors that make public borrowing difficult such as larger official debt and higher borrowing cost induce politicians to resort to hiding debt. Second, certain institutional characteristics such as strong credibility and transparency in the government sector reduce the willingness of politicians to arrange hidden expenditures because it becomes more costly to hide debt. Third, the transition from the cash-based accounting method to the accrual-based one helps reduce hidden debt, but countries that are not credible may run hidden debt even under the accrual-based system. In Chapter 3, we investigate the determinants of sovereign bond credit spreads in emerging market countries. First, the increases in government debt lead to a widening of the spreads because a higher debt level raises the concerns over default on sovereign debt. Second, we find that the market participants consider the role of fiscal institutions when pricing the risk premia of sovereign bonds. Better fiscal institutions tend to mitigate the widening of credit spreads from increases in debt. Furthermore, the negative impact of additional borrowing on spreads will be negligible if a country has good fiscal institutions. Lastly, the socio-political characteristics of a country such as contract reliability and observance of law also play important roles in determining the level of sovereign bond spreads