Can Interest Rate Spreads Stabilize the Euro Area?

Abstract

Since the creation of the euro area significant interest rate spreads have arisen between Euro area countries, both for public and private debt. We check whether these spreads could be made to work towards the goal of providing more stability to the Euro area. In particular we focus on reducing the imbalances that arose between the core and peripheral members of the Euro area in the first decade of its existence. The idea is that stable positive spreads in peripheral countries could have decreased domestic demand, preventing the boom-bust cycles that plagued these economies. They could also prevent such developments in the future. We find that spreads on real interest rates of 0.6 to 5.5 percentage points would have been necessary to stabilize external positions of the four peripheral Euro area member countries.