Do credit rating agencies reward fiscal prudence?

Abstract

Governments are responsible for economic policy implementation, and their actions affect financial and capital market outcomes. Specifically, the way fiscal policy is conducted matters when credit agencies have to decide on how to rate a sovereign. This paper empirically assesses the effect of a new time-varying measure of fiscal counter-cyclicality on the sovereign credit ratings of the main agencies: Fitch, Standard & Poor's, and Moody's. I focus on a heterogeneous sample of 63 advanced and developing economies between 1980 and 2015. First, we find that the degree of fiscal counter-cyclicality is generally positive and has been increasing over time, being larger in advanced economies. Second, the more counter-cyclical a fiscal policy is, the better the assessment a rating agency gives to that country, particularly if it is an advanced one. This suggests that fiscal prudence and stabilization concerns are rewarded. Our results are robust to several sensitivity and robustness checks.