Euro bonds: in search of financial spillovers
Universita Degli Studi di Trento Discussion Paper
Trento : Università degli Studi di Trento
Universita Degli Studi di Trento Discussion Paper : 2
Spillovers, Stability and Growth Pact, EMU, government bonds
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.