Working Paper

The Effect of Different Types of Public Spending on Sovereign Yields: Where the Money Goes

This paper investigates whether financial markets distinguish between different categories of government expenditure when pricing sovereign debt. Using a panel of 39 advanced and developing economies over up to 40 years, we examine the effects of public investment, government consumption, and defense spending on sovereign financing costs. We find that public investment is associated with lower yields and lower debt service costs, while government consumption has no significant effect. The beneficial effect of public investment is smaller in euro area countries, suggesting that institutional settings matter for the pricing of fiscal policy. By contrast, higher defense expenditure does not reduce sovereign borrowing costs.

Keywords: Sovereign bond yields, Public investment, Defense spending, Euro area, Staatsanleiherenditen, Öffentliche Investitionen, Verteidigungsausgaben, Euroraum