Overview: The paper investigates the empirical relevance
of the negative financial spillovers hypothesis according to which
fiscal imbalances in one EMU member country bid up the interest
rate faced by all other participants in the currency union. This
idea questions the ability of financial markets to correctly price
various types of risk now that the elimination of exchange rate
fluctuations and the rapid integration of national government
bond markets have made securities issued by different European
governments closer substitutes. The paper takes an eclectic approach
and tackles the issue from different angles, reviewing historical
episodes, testing the Ricardian equivalence hypothesis in Europe
as a whole and finally analyzing the impact of domestic and foreign
fiscal variables on European bond yields. Despite the strong comovements
displayed by European interest rates, empirical evidence does
not support the idea that fiscal variables are a key determinant
of these interrelations.
Tags: Euro Bonds, Spillovers, Stability and Growth Pact,
EMU, government bonds
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Source: SSRN
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