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Fiscal space and sovereign risk pricing in a currency union

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  • Ghosh, Atish R.
  • Ostry, Jonathan D.
  • Qureshi, Mahvash S.

Abstract

We examine how membership in a currency union affects public debt sustainability and market assessments of default risk in eurozone countries. We argue that there exist offsetting effects: expectations of bailouts tend to make a given level of debt more sustainable, lowering bond yields and CDS rates, but constraints on the use of monetary policy would tend to have the opposite effect, pushing rates up especially as room for fiscal maneuver gets exhausted. We develop a formal concept of fiscal space (which takes account of the notion of fiscal fatigue under which there are limits to the government's ability to raise the primary surplus in response to higher debt), and apply it to the eurozone countries, investigating in particular how currency union membership affects CDS and bond rates during both quiet and turbulent times for a given amount of fiscal space. We find that in quiet times, CDS and bond rates for eurozone members were below what would be expected given their fiscal space (a bonus from currency union membership). But when the crisis erupted, CDS and bond yields rose more sharply for eurozone members than would be predicted based on their available fiscal space. Our interpretation is that sovereign bailouts did not occur with the hoped-for alacrity in euro-crisis countries, generating sharper penalties for sovereigns that belong to a currency union.

Suggested Citation

  • Ghosh, Atish R. & Ostry, Jonathan D. & Qureshi, Mahvash S., 2013. "Fiscal space and sovereign risk pricing in a currency union," Journal of International Money and Finance, Elsevier, vol. 34(C), pages 131-163.
  • Handle: RePEc:eee:jimfin:v:34:y:2013:i:c:p:131-163
    DOI: 10.1016/j.jimonfin.2012.11.008
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    1. repec:agr:journl:v:3(612):y:2017:i:3(612):p:63-70 is not listed on IDEAS
    2. Pierre ALDAMA & Jérôme Creel, 2017. "Fiscal policy in the US : Ricardian after all ?," Documents de Travail de l'OFCE 2017-23, Observatoire Francais des Conjonctures Economiques (OFCE).
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    4. Heinemann, Friedrich & Osterloh, Steffen & Kalb, Alexander, 2014. "Sovereign risk premia: The link between fiscal rules and stability culture," Journal of International Money and Finance, Elsevier, vol. 41(C), pages 110-127.
    5. Falilou Fall & Debra Bloch & Jean-Marc Fournier & Peter Hoeller, 2015. "Prudent debt targets and fiscal frameworks," OECD Economic Policy Papers 15, OECD Publishing.
    6. Kobielarz, Michal, 2018. "The economics of monetary unions," Other publications TiSEM b0293536-68ec-4905-bffd-6, Tilburg University, School of Economics and Management.
    7. Jeanneret, Alexandre & Souissi, Slim, 2016. "Sovereign defaults by currency denomination," Journal of International Money and Finance, Elsevier, vol. 60(C), pages 197-222.
    8. repec:eee:inecon:v:113:y:2018:i:c:p:1-19 is not listed on IDEAS
    9. Feld, Lars P. & Kalb, Alexander & Moessinger, Marc-Daniel & Osterloh, Steffen, 2017. "Sovereign bond market reactions to no-bailout clauses and fiscal rules – The Swiss experience," Journal of International Money and Finance, Elsevier, vol. 70(C), pages 319-343.
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    14. Gunther Capelle-Blancard & Patricia Crifo & Marc-Arthur Diaye & Rim Oueghlissi & Bert Scholtens, 2016. "Environmental, Social and Governance (ESG) performance and sovereign bond spreads: an empirical analysis of OECD countries," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-01401718, HAL.
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    16. repec:agr:journl:v:xxiv:y:2017:i:2(611):p:5-20 is not listed on IDEAS
    17. Katia Berti & Eugeniu Colesnic & Cyril Desponts & Stephanie Pamies & Etienne Sail, 2016. "Fiscal Reaction Functions for European Union Countries," European Economy - Discussion Papers 2015 - 028, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
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    19. Nazim Belhocine & Salvatore Dell'Erba, 2013. "The Impact of Debt Sustainability and the Level of Debt on Emerging Markets Spreads," IMF Working Papers 13/93, International Monetary Fund.
    20. Chiarella, Carl & ter Ellen, Saskia & He, Xue-Zhong & Wu, Eliza, 2015. "Fear or fundamentals? Heterogeneous beliefs in the European sovereign CDS market," Journal of Empirical Finance, Elsevier, vol. 32(C), pages 19-34.

    More about this item

    Keywords

    Fiscal space; Sovereign risk pricing; Eurozone;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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