ARE FISCAL RULES CONDUCIVE TO PRIVATE CREDIT GROWTH?
This paper studies the relationship between fiscal rules and private credit growth. A wealth of literature on fiscal rules has primarily praised their ability to reduce deficits and mitigate the negative consequences of financial busts. This paper suggests another facet of fiscal rules and proposes two transmission channels through which they may lead to private credit growth. First, fiscal rules improve economic fundamentals, such as lower inflation volatility, higher sovereign credit ratings, and lower sovereign bond interest rates. These macroeconomic improvements reduce uncertainty and may reassure investors in their market positions and projections, pos- sibly exacerbating their optimism and crowding-in private investment. Second, willingness to invest may be exacerbated by political incentives to engineer credit-based consumption and investment in the presence of fiscal constraints. In this respect, governments might fuel finan- cial activity by taking control of banking regulation, providing deposit guarantees, and relaxing credit controls. Put in a nutshell, I hypothesize that fiscal rule strength increases private lever- age. Empirical results corroborate that fiscal rule strength has a positive effect on private credit, although this effect is not necessarily conducive to unsustainable levels of private leverage (i.e. to systemic banking crises). This paper aims to contribute to a growing literature emphasizing the importance of fiscal policy for financial stability.
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