The euro area's common default risk: Evidence on the Commission's impact on European fiscal affairs

Abstract

Sovereign creditworthiness within the euro area hinges upon the credibility of the Stability and Growth Pact (SGP). We analyse whether political events that worsen the SGP's credibility result in a shared default risk premium for all euro members, therefore leading to a joint deterioration of creditworthiness. We especially examine the decisions and statements of the Commission and the Council of Economic and Finance Ministers. Analysing daily data through the 1999–2005 period with an ARMA-GARCH model, we find the Commission plays a decisive role in affecting investor evaluations, where its credibility-strengthening decisions decrease volatility and statements signalling a weakening of fiscal credibility spark uncertainty on financial markets. Our results stress the importance of creating credible fiscal institutions that preserve sovereign creditworthiness within the euro area.

Keywords

EU Commission euro area fiscal policy sovereign default risk Stability and Growth Pact volatility

Get full access to this article

View all access options for this article.

References

Afonso

Strauch

(2007) Fiscal policy events and interest rate swap spreads: Evidence from the EU. Journal of International Financial Markets, Institutions and Money 17(3): 261–272.

Bechtel

Schneider

(2010) Eliciting substance from ‘hot air’: Financial market responses to EU summit decisions on European defense. International Organization 64(2): 199–223.

Beetsma

Giuliodori

(2010) The macroeconomic costs and benefits of the EMU and other monetary unions: an overview of recent research. Journal of Economic Literature 48(3): 603–641.

Bernhard

Broz

Clark

(2002) The political economy of monetary institutions. International Organization 56(4): 693–723.

Bernoth

Von Hagen

Schuknecht

(2004) Sovereign risk premia in the European government bond market. ECB Working Paper No 369–369.

Bicksler

Chen

(1986) An economic analysis of interest rate swaps. Journal of Finance 41(3): 645–655.

Binder

(1998) The event study methodology since 1969. Review of Quantitative Finance and Accounting 11(2): 111–137.

Bollerslev

(1986) Generalised autoregressive conditional heteroscedasticity. Journal of Econometrics 31(2): 307–327.

Buti

Van Den Noord

(2004) Fiscal discretion and elections in the early years of EMU. Journal of Common Market Studies 42(4): 737–756.

10.

Codogno

Favero

Missale

(2003) Yield spreads on EMU government bonds. Economic Policy 18(37): 503–532.

11.

De Haan

Berger

Jansen

(2004) Why has the Stability and Growth Pact failed?. International Finance 7(2): 235–260.

12.

Duffie

Singleton

(1997) An econometric model of the term structure of interest-rate swap yields. Journal of Finance 52(4): 1287–1321.

13.

Engle

(1982) Autoregressive conditional heteroscedasticity with estimates of the variance of U.K. inflation. Econometrica 50(4): 987–1008.

14.

Faini

(2006) Fiscal policy and interest rates in Europe. Economic Policy 21(47): 443–489.

15.

Freeman

Hays

Stix

(2000) Democracy and markets: the case of exchange rates. American Journal of Political Science 44(3): 449–468.

16.

Gray

(2009) International organization as a seal of approval: European Union accession and investor risk. American Journal of Political Science 53(4): 931–949.

17.

Hallerberg

Wolff

(2008) Fiscal institutions, fiscal policy and sovereign risk premia in EMU. Public Choice 136(2): 379–396.

18.

Heipertz

Verdun

(2010) Ruling Europe: the Politics of the Stability and Growth Pact. Cambridge: Cambridge University Press.

19.

Heppke-Falk

Hüfner

(2004) Expected budget deficits and interest rate swap spreads – evidence for France, Germany and Italy. Deutsche Bundesbank Discussion Paper Series 1, Studies of the Economic Research Centre No. 40.

20.

Kydland

Prescott

() Rules Rather Than Discretion: The Inconsistency of Optimal Plans. Journal of Political Economy 85(3): 473–492.

21.

Leblond

(2006) The political Stability and Growth Pact is dead: Long live the economic Stability and Growth Pact. Journal of Common Market Studies 44(5): 969–990.

22.

Lemmen

JJG

Goodhart

CAE

(1999) Credit risks and European government bond markets: a panel data econometric analysis. Eastern Economic Journal 25(1): 77–107.

23.

MacKinlay

(1997) Event studies in economics and finance. Journal of Economic Literature 35(1): 13–39.

24.

Mink

De Haan

(2006) Are there political budget cycles in the euro area?. European Union Politics 7(2): 191–211.

25.

Mosley

(2004) Government–financial market relations after EMU: New currency, new constraints?. European Union Politics 5(2): 181–209.

26.

Prast

De Vor

MPH

(2005) Investor reactions to news: a cognitive dissonance analysis of the euro–dollar exchange rate. European Journal of Political Economy 21(1): 115–141.

27.

Simmons

(2000) International law and state behavior: Commitment and compliance in international monetary affairs. American Political Science Review 94(4): 819–835.

28.

Wyplosz

(2006) The European Monetary Union: the dark sides of a major success. Economic Policy 21(46): 207–261.

Supplementary Material

Please find the following supplemental material available below.

For Open Access articles published under a Creative Commons License, all supplemental material carries the same license as the article it is associated with.

For non-Open Access articles published, all supplemental material carries a non-exclusive license, and permission requests for re-use of supplemental material or any part of supplemental material shall be sent directly to the copyright owner as specified in the copyright notice associated with the article.

0.03 MB

0.00 MB

0.01 MB