Financial markets and fiscal discipline in the Eurozone

Abstract

The paper aims to investigate the existence of a trade-off between financial market confidence and national government budget dynamics in the Eurozone. By comparing two indexes, the hypothesis of the existence of a constraint between credit default swaps and public deficits from 2009:I to 2014:I is tested. The results support the conclusion that – during the period of the Euro crisis – fiscal discipline was associated with decreasing confidence, and vice versa. The estimates identify a phenomenon whose prior is not set, suggesting that the decrease in financial market confidence comes with fiscal retrenchments, but also that fiscal retrenchments combine, other things being equal, with financial distress. The inability of financial markets to determine coherent behaviour in regard to fiscal stance provides grounds for thought on the need for common policy actions in the Eurozone. Show more