We provide evidence that the movements in yield differentials between euro zone government bonds explained by changes in international risk factors -as measured by banking and corporate risk premiums in the United States -are more pronounced for bonds issued by Italy and Spain. Liquidity factors play a smaller role, so policies meant to increase financial market efficiency do not appear sufficient to deliver a 'seamless' bond market in the euro area. The risk of default is a small but important component of yield differentials movements, which signal market perceptions of fiscal vulnerability, impose market discipline on national fiscal policies, and may be reduced only by further convergence in debt ratios.

The key question in estimating the effects of fiscal policy on output is how to identify shifts in fiscal policy that are "exogenous", that is are not a response to the state of output -as would be the case, for instance, of a fiscal expansion induced by a fall in output. Following the approach pioneered by Romer and Romer (2010), Devries at al (2011) have collected and described -using the records available in official documents -the multi-year fiscal consolidation plans announced (and then implemented or revised) by seventeen OECD countries over a quarter of a century . Among all stabilization plans these authors have selected those that were designed to reduce a budget deficit and to put the public debt on a sustainable path, which should guarantee their "exogeneity".Using the Devries et al (2011) data we have been able to make progress on question of anticipated versus unanticipated shifts in fiscal policy and permanent versus transitory shifts. We find that it matters crucially how the consolidation occurs. Fiscal adjustments based upon spending cuts are much less costly in terms of output losses than tax-based ones. The difference is remarkable in its size and it cannot be explained by different monetary policies during the two types of adjustments. We find instead that the heterogeneity in the effects of the two types of fiscal adjustments is mainly due to the response of private investment, rather than that to consumption growth. Interestingly, the responses of business and consumers' confidence to different types of fiscal adjustment show the same asymmetry as investment and consumption: business confidence (unlike consumer confidence) picks up immediately after expenditure-based adjustments.The strength and the statistical significance of our results depend crucially on the innovative approach that we adopt to simulate the impact of fiscal adjustments. Rather than simulating the impact of exogenous fiscal shocks, we study the response of output (and of the other variables of interest) to multi-period fiscal consolidation plans -that is sequences of tax increases and spending cuts, announced in some year and then implemented or revised in subsequent years. We allow for differences in the "style" of these plans across countries, and we show that these differences are a critical factor in order to obtain more precise estimates of the response of the economy to a consolidation plan.The output effect of fiscal consolidation plans Alberto Alesina, Carlo Favero and Francesco Giavazzi * This version: October 2014 AbstractWe show that the correct experiment to evaluate the effects of a fiscal adjustment is the simulation of a multi year fiscal plan rather than of individual fiscal shocks. Simulation of fiscal plans adopted by 16 OECD countries over a 30-year period supports the hypothesis that the effects of consolidations depend on their design. Fiscal adjustments based upon spending cuts are much less costly, in terms of output losses, than tax-based ones and have especially low output costs when they consist...

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The paper explores the determinants of yield differentials between sovereign bonds, using Euro area data. There is a common trend in yield differentials, which is correlated with a measure of aggregate risk. In contrast, liquidity differentials display sizeable heterogeneity and no common factor. We propose a simple model with endogenous liquidity demand, where a bond's liquidity premium depends both on its transaction cost and on investment opportunities. The model predicts that yield differentials should increase in both liquidity and risk, with an interaction term of the opposite sign. Testing these predictions on daily data, we find that the aggregate risk factor is consistently priced, liquidity differentials are priced for a subset of countries, and their interaction with the risk factor is in line with the model's prediction and crucial to detect their effect. JEL classification numbers: E43, G12.

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