The Sovereign Yield Curve and Fiscal Behaviour in China

Abstract

The present study aims to explore the relationship between the sovereign yield curve and fiscal behaviour in China. The Chinese Government is very powerful, and fiscal policy plays an important role in China's economy. A dynamic Nelson–Siegel model is adopted to estimate the level, slope and curvature factors of the yield curve. Three aspects of fiscal behaviour, including government spending, revenue and budget balance, are considered. Significant relationships between fiscal behaviour and the sovereign yield curve are found and described in the present study. Higher government expenditure raises the level and slope factors of the yield curve, while increasing government revenue reduces the level factor and enhances the slope factor. Furthermore, improved budget balance decreases the level and slope factors of the yield curve. Fiscal behaviour also interacts with the macroeconomy in China. Fiscal policy is insensitive to price surges in contrast to the strong responses of monetary policy to higher inflation. In addition, crowding†out effects of government spending are demonstrated in this study.