The Dynamic Link between Bond Spreads and Fiscal Indicators: An Empirical Investigation of Turkey
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Abstract
In this study, the dynamic relationship between government bond spreads and fiscal indicators is analyzed through different macroeconomic, fiscal, and financial variables with evidence from Turkey. A quarterly time series data set, from 2006:Q1 to 2019:Q3, is used to estimate the vector autoregression (VAR) model. The VAR model is used to determine a possible causal relationship between variables and to identify transmission of a shock in the model. The results show that there is a one-way causality from government bond spreads to fiscal indicators. Additionally, impulse-response functions reveal that the reaction of gross external debt to a shock in bond spreads is statistically more significant vis-à-vis the reaction of the primary budget balance. That is to say, gross external debt is found to be a more appropriate fiscal indicator in providing resiliency to global shocks compared to the primary budget balance for Turkey. The implication for this result in our analyses is that since bond spreads explain changes in fiscal indicators, not vice versa, the Turkish government should reduce external debt to lessen the effect of bond spreads and apply robust policies that would enhance fiscal solvency to create fiscal space to be used as a bulwark against short run shocks.
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