Can re-regulation of the financial sector strike back public debt?☆

a r t i c l e i n f o This paper analyses the impact of financial sector policy changes on the dynamics of public debt. Using a panel of 89 countries from 1973 to 2005, we find that, overall, while the implementation of financial liberalisation policies significantly raises the public debt growth rate, the adoption of financial re-regulation measures does not reduce it in a significant manner. Looking at the different typologies of financial sector policy changes, we show that restrictions to international capital flows contribute to a decline in the growth rate of public debt. In contrast, the removal of entry barriers boosts public debt growth. Finally, our results suggest that financial reversals may help to reduce the growth rate of public debt only when the public debt-to-GDP ratio or the inflation rate is high. While public debt is not a new phenomenon for developing countries , fiscal deficits have been growing in a wide range of developed countries over the last 30 years. More recently, the financial crisis of 2008–2009 forced many governments to adopt fiscal policy measures aimed at offsetting its damaging effects and at delivering an economic recovery from a very sharp collapse of the asset markets (Agnello et al., 2012). This has ultimately led to costly government restructuring of private sector's balance sheet, a significant increase in public debt, a steep rise in sovereign yield, and lower degree of business cycle synchronisation across countries , and had significant implications in a large number of social outcomes (Mallick and Mohsin, 2010). Reinhart and Rogoff (2011a, 2011b) show that domestic debt currently accounts for almost two thirds of total public debt. With public debt reaching historically high record levels, debt restructuring appears to be unavoidable for some governments. Therefore, it seems reasonable to assume that debt reduction, debt management, and efforts to lower the debt servicing costs will be at the centre of the political agenda in the coming years. As Fujita (2011) correctly points, the most recent international financial turmoil brought more state activism and market regulation. Reinhart (2012) also emphasises financial repression measures as one potential mechanism for the reduction of the debt-to-GDP ratios. Werner (2013) highlights the need to understand the role of banking systems as precondition for the design of optimal policy interventions. Although these works theoretically discuss the intensification of regulation measures as one of the consequences of the Great …