Over the past decade, economists such as Nobel laureate Paul Krugman have increasingly urged countries to embrace more government borrowing. But too much debt can become a significant problem. Indeed, it looks as if, specifically during periods of crisis, nations with stretched finances are more than likely to be penalised by financial markets and see their borrowing costs rise. And this of course has significant implications for fiscal policy.

In recent research, we focused on 30 developed countries in the Americas, Europe and the Asia-Pacific region, as well as 23 U.S. states, to measure the direct effect of shocks to economic growth, measured by the spread of the COVID-19 pandemic, on government borrowing costs.

We used data from the credit default swap (CDS) market to see how much the cost of borrowing changed for each state or country — CDS premiums frequently rise and fall as investors alter their views on the perceived risks of lending to individual countries or states. Our study focused on the time between 1 January 2020, when the World Health Organization activated its emergency response framework, and 18 May 2020, when a 500 billion Euro European Union recovery fund was proposed.

Read the full Global Banking and Finance Review article.

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Marti Subrahmanyam is the Charles E. Merrill Professor of Finance, Economics and International Business