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

Abstract

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.