Abstract
AbstractWith the announcement to intervene on financial markets to restore the monetary transmission mechanism, the ECB has attenuated the pressure of the markets on the endangered peripheral countries of the Eurozone. Critics argue that by eliminating the markets’ disciplining interest mechanism, governments in the crisis countries will not carry out reforms and consolidate their budgets. This kind of interplay between public deficit policy and financial markets is commonly discussed under the notion of Market Discipline Hypothesis. The hypothesis’ second half suggests that governments react to rising interest rates by adjusting their deficit policy. Based on panel data for the European Union, different models are tested to investigate if governments react to rising interest rates. The results indicate that governments do raise their primary surpluses when they perceive the rising interest rates in their budgets. Governments react quite quickly to changing interest rates, although there seems to be some ...
Highlights
During the ongoing crisis in the euro area, several uncommon political measures were taken in order to overcome the crisis
The results show that critics have good reasons to doubt the success of Draghi’s unconventional measure: Governments do react to changing bond yields on the secondary market by raising primary surpluses
The final result of the regressions presented above is that governments do react to rising borrowing costs by raising primary surpluses
Summary
During the ongoing crisis in the euro area, several uncommon political measures were taken in order to overcome the crisis. For a panel of OECD countries Heinemann and Winschel (2001) find asymmetric reactions of governments facing changing borrowing conditions (defined here as the difference between real interest and real growth rates): While there is a clear reaction of rising primary surpluses in times of deteriorating borrowing conditions, the reaction in times of improving conditions is less pronounced. The results show that critics have good reasons to doubt the success of Draghi’s unconventional measure: Governments do react to changing bond yields on the secondary market by raising primary surpluses. They do react to rising effective interest payments by raising the primary surplus.
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