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A Tale of Five PIIGS: Soft Budget Constraints and the EMU Sovereign Debt Crises

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  • Thushyanthan Baskaran

    ()
    (Department of Economics, University of Göttingen, Germany)

  • Zohal Hessami

    ()
    (Department of Economics, University of Konstanz, Germany)

Abstract

Why are so many EU countries currently in dire fiscal straits? A popular explanation is that monetary unification led to bailout expectations, which in turn resulted in soft budget constraints and over-borrowing. This paper investigates the validity of this explanation by studying the effects of the Maastricht treaty and the introduction of the Euro on public deficits. To identify the causal effects of these last two stages of EMU, we apply the difference- in-difference methodology to a dataset that covers 26 OECD countries (including all EU-15 countries) over the 1975-2009 period. The estimations suggest that the effect of the EMU on deficits is limited to the so-called PIIGS countries. The signing of the Maastricht treaty triggered a reduction of deficits in this group of countries. Once the Euro had been introduced, the PIIGS expanded their deficits – but only to pre Maastricht levels. In other words, the Euro led to soft budget constraints, and the PIIGS exploited these soft budget constraints to some extent (but not excessively). From a policy perspective, our findings favor reforms in the direction of administrative rather than fiscal centralization for the EU.

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Bibliographic Info

Paper provided by Department of Economics, University of Konstanz in its series Working Paper Series of the Department of Economics, University of Konstanz with number 2011-45.

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Length: 30 pages
Date of creation: 13 Nov 2011
Date of revision:
Handle: RePEc:knz:dpteco:1145

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Related research

Keywords: EMU; PIIGS; monetary union; budget deficits; soft budget constraints;

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References

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  1. Afonso, António & Rault, Christophe, 2007. "What do we really know about fiscal sustainability in the EU? A panel data diagnostic," Working Paper Series 0820, European Central Bank.
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  7. Baskaran, Thushyanthan, 2009. "Did the Maastricht treaty matter for macroeconomic performance?," MPRA Paper 30106, University Library of Munich, Germany.
  8. Wyplosz, Charles, 1997. "EMU: Why and How It Might Happen," CEPR Discussion Papers 1685, C.E.P.R. Discussion Papers.
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  13. Baskaran, Thushyanthan, 2011. "Soft budget constraints and strategic interactions in subnational borrowing: Evidence from the German States, 1975-2005," MPRA Paper 32537, University Library of Munich, Germany.
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Cited by:
  1. Mitu Gulati, 2013. "The Evolution of Euro Area Sovereign Debt Contract Terms: A Preliminary Examination," CESifo DICE Report, Ifo Institute for Economic Research at the University of Munich, vol. 11(3), pages 03-09, October.

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