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This study looks at the interrelationship between fiscal policy and safe assets as there is surprisingly little analysis about this beyond fleeting references. The study argues that from a certain point more public debt will not “buy” more safety: countries face a kind of “safe-assets Laffer curve” with a maximum amount of safe assets at some level of indebtedness. The position and “stability” of this curve depend on a number of national and international factors, including the international risk appetite and, as a more recent factor, QE policies by central banks. The study also finds evidence of declining safe assets as reflected in government debt ratings.
The paper analyses the linkages from financial developments to public finances. It maps and discusses the transmission channels to fiscal variables. These channels include asset prices, financing conditions, balance sheets of banks, non-banks and central banks and international linkages. The study argues that the fiscal effects via each and all these channels can be very serious in magnitude and can put the sustainability of public finances at risk. However, there is an only limited in-depth analysis of these channels and risks.
This paper compares the boom-bust cycle in Finland and Sweden 1984-1995 with the average boom-bust pattern in industrialized countries as calculated from an international sample for the period 1970-2002. Two clear conclusions emerge. First, the Finnish-Swedish experience is much more volatile than the average boom-bust pattern. This holds for virtually every time series examined. Second, the bust and the recovery in the two Nordic countries differ markedly more from the international pattern than the boom phase does. The bust is considerably deeper and the recovery comes earlier and is more rapid. We explain the highly volatile character of the Finnish and Swedish boom-bust episode by the design of economic policies in the 1980s and 1990s. The boom-bust cycle in Finland and Sweden 1984-1995 was driven by financial liberalization and a hard currency policy, causing large pro-cyclical swings in the real rate of interest transmitted via the financial sector into the real sector and then into the public finances. JEL Classification: E32, E62, E63
