Sovereign Credit Ratings under Fiscal Uncertainty

Abstract

This paper studies the response of credit rating agencies to an increase in uncertainty about a government's fiscal position. To that end, a measure of the uncertainty around official forecasts of the public budget deficit is constructed that is comparable across time and a range of advanced economies. To estimate the effect of fiscal uncertainty on sovereign credit ratings, an empirical framework is developed that accounts for the high stability of ratings over time. Results suggest that fiscal uncertainty increases the predictive power of a model of rating changes and can explain why sovereign ratings are often changed more frequently during crises.