Institutions, Deficits, and Wars: The Determinants of British Government Borrowing Costs from the End of the Seventeenth Century to 1850

We present historical data on sovereign bond spreads drawn from 300 years of data (from the late seventeenth century to the late twentieth century), which appear to be inconsistent with the North and Weingast (1989) view that institutional changes and reforms can reduce the cost of government debt soon after they are implemented. Extended time series data on British government debt from the late seventeenth century until 1850 show that, for over a century after the Glorious Revolution, and even in the nineteenth century, wars and episodes of instability were a significant and robust determinant of the risk premium on British government debt. Furthermore, we show that the effect of wars on the cost of debt is due in part to an increase in ―country risk,‖ not only to war-induced budget deficits. This evidence is inconsistent with the claim made by Barro (1987) according to which the increase in interest rates was due to temporary increases in government spending. Results reproduced from Sussman and Yafeh (2000) suggest that in nineteenth century Japan, as well as in large samples of emerging markets in the period 1870-1913 and in the 1990s (Mauro, Sussman and Yafeh, 2006) wars and political instability were strongly correlated with the cost of debt, whereas institutional changes were not. Our overall reading of the historical evidence is therefore that institutional reforms rarely have a rapid and significant impact on bond spreads which tend to respond, at least in the short run, primarily to crises and instability.