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Boom-bust cycles, imbalances and discipline in Europe

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Author Info

  • Enrique Alberola

    ()
    (Banco de España)

  • Luis Molina

    ()
    (Banco de España)

  • Pedro del Río

    ()
    (Banco de España)

Abstract

The fallout from the 2008 financial crisis has been particularly acute in the euro area Member States of the south-western rim and in the new EU Member States, due to their previously accumulated macroeconomic and financial imbalances. The perception that the euro environment provided a solid shield against economic instability shaped the incentives, expectations and actions of agents, markets and policymakers. This, in turn, eroded discipline at all levels: EU-wide surveillance, domestic policies and markets. The empirical analysis of this paper, focused on market discipline, shows that before the crisis credit risk premia neglected fiscal imbalances and hardly reflected external or financial imbalances, in particular in advanced economies. This result is partly explained by the masking effect of the expansionary phase on underlying imbalances. The crisis has shattered the perception of the euro as a safe haven for economic stability, where imbalances do not matter. Moreover, the severity of the crisis has uncovered the fragilities of the institutional framework underpinning the euro and is leading to its reinforcement by means of stronger economic governance and surveillance. Going forward, however, a further two factors may exert a greater impact on the future discipline and stability of the European economies: i) more stringent financing conditions by markets, contingent on fundamentals, although there are doubts on the persistence of this discipline in future expansionary phases; and, above all ii) domestic policymaking conduct that is consistent with the constraints that EMU entails. These three forces could settle the European integration process and EMU on a more solid footing, although the jury is still out.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/12/Fich/dt1220e.pdf
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Bibliographic Info

Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 1220.

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Length: 40 pages
Date of creation: Jun 2012
Date of revision:
Handle: RePEc:bde:wpaper:1220

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Related research

Keywords: Financial crisis; fiscal discipline; credit risk; euro area; CDS;

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References

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  1. Bernoth, Kerstin & von Hagen, Jürgen & Schuknecht, Ludger, 2003. "Sovereign risk premia in the European government bond market," ZEI Working Papers B 26-2003, ZEI - Center for European Integration Studies, University of Bonn.
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Cited by:
  1. Carmen Broto & Gabriel Perez-Quiros, 2013. "Disentangling contagion among sovereign cds spreads during the european debt crisis," Banco de Espa�a Working Papers 1314, Banco de Espa�a.

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