Many governments of both rich and poor countries worry a great deal about ‘market confidence’ and use that as a rationale (at least in terms of public statements) for guiding the design and conduct of macroeconomic policy as well as structural reforms. Inflation nudging above the 5 per cent mark that we set as our target? We better do something about it because the ‘market’ will get annoyed. Debt to GDP ratio inching above 60 per cent? Well, we should start a process of fiscal consolidation soon or else we might lose our favourable credit rating that has been bestowed on us by the omnipresent ‘market’ (which often appears to be a synonym for credit rating agencies). We need to have flexible labour markets through structural reforms because the market complains about our rigid labour laws which act as a disincentive to invest.
There is insufficient reflection in public discourse on what ‘market confidence’ really means. Are we talking about domestic or foreign investors? Why should be only talk about the ‘confidence’ of the ‘market’ rather than the community at large? After all, the ‘market’ is embedded in a community and polity. Why discuss a part of it and not the whole? In any case, what is the evidence about the determinants of ‘market confidence’?
One can easily overlook the fact that multiple studies show that formal assessments of sovereign credit worthiness by credit rating agencies routinely include growth indicators in addition to measures of debts and deficits (see, for example, Iyanatul Islam and Martina Hengge, https://www.socialeurope.eu/2012/07/fiscal-austerity-borrowing-costs-and-the-eurozone-economies/). What is perhaps less well-known is that growth has a more significant impact on sovereign default risks than debts and deficits. The implication is that cutting deficits to reduce public debt might be self-defeating given that such actions typically reduce growth raising doubts among ‘bond vigilantes’ about the sustainability of fiscal austerity measures.