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Government spending news and the term structure of interest rates

September 22, 2014

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2014. The project is a required component of every master program.


Government spending news and the term structure of interest rates

Authors:

Nicola Cofelice and Sarah Zoi

Master Program:

Macroeconomic Policy and Financial Markets

Paper Abstract:

Studying the effect of a fiscal policy shock on the term structure of interest rates has long been a controversial issue. On the one hand, economic theory predicts that government spending should drive up interest rates; on the other hand, many empirical analyses found negative or not significant responses of the yield curve to different types of fiscal shocks. A recent stream of literature on fiscal foresight showed how news about future fiscal policy may anticipate the effects of public expenditure and pose a challenge for the recovery of structural shocks due to a problem of non-fundamentalness. We study the effect of a “foresight shock” on the term structure of interest rates using an identification strategy based on the information contained in the projections by the Survey of Professional Forecasters. Our results support the evidence of fiscal foresight and show how changes in expectations stimulate positive responses of the term structure anticipating the effects of a government spending shock.

Read the full paper or view slides below:

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