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Convergence of Government Bond Yields in the Euro Zone: The Role of Policy Harmonization

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  • Denise Côté
  • Christopher Graham

Abstract

Since the early 1980s, long-term government bond yields in the euro zone have declined, in line with those in other industrialized countries. In this paper, the authors examine the monetary and fiscal policies adopted by European countries on the path to Economic and Monetary Union (EMU), and assess how these policies, including the introduction of the common currency, have contributed to the convergence of national long-term government bond yields in the euro zone. The authors find evidence that increased harmonization of monetary and fiscal policies on the path to EMU contributed greatly to the convergence of long-term government bond yields in the euro zone. More importantly, their findings suggest that the convergence of national long-term government bond yields in the euro zone cannot be attributed primarily to the introduction of the common currency itself, since two control groups of other OECD countries experienced a similar convergence. The first control group consists of other European Union (EU) countries not included in EMU (Denmark, Sweden, and the United Kingdom), and the second group includes other OECD countries that are members of neither EMU nor the EU (Australia, Canada, Norway, and Switzerland). The authors also find evidence that currency risk premiums declined gradually following the adoption of the Maastricht Treaty and were largely eliminated by the time the single currency was introduced in January 1999. These findings suggest that, in the context of integrated international financial markets, harmonization of sound monetary and fiscal policies across countries will cause national long-term bond yields to converge. Based on evidence from the euro zone, the adoption of a common currency will have, at most, a secondary effect on the convergence of national bond yields.

Suggested Citation

  • Denise Côté & Christopher Graham, 2004. "Convergence of Government Bond Yields in the Euro Zone: The Role of Policy Harmonization," Staff Working Papers 04-23, Bank of Canada.
  • Handle: RePEc:bca:bocawp:04-23
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    Cited by:

    1. repec:eee:intfin:v:49:y:2017:i:c:p:129-139 is not listed on IDEAS
    2. Lucjan T. Orlowski & Kirsten Lommatzsch, 2005. "Bond Yield Compression in the Countries Converging to the Euro," William Davidson Institute Working Papers Series wp799, William Davidson Institute at the University of Michigan.
    3. Hoffmann Andreas, 2013. "The Euro as a Proxy for the Classical Gold Standard? Government Debt Financing and Political Commitment in Historical Perspective," Journal des Economistes et des Etudes Humaines, De Gruyter, pages 41-61.
    4. Sebastian Missio, 2012. "Government bond market integration and the EMU: Correlation based evidence," Working Papers 125, Bavarian Graduate Program in Economics (BGPE).
    5. Antonakakis, Nikolaos & Christou, Christina & Cunado, Juncal & Gupta, Rangan, 2017. "Convergence patterns in sovereign bond yield spreads: Evidence from the Euro Area," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 49(C), pages 129-139.
    6. Leo Haan & Elmer Sterken, 2011. "Bank-Specific Daily Interest Rate Adjustment in the Dutch Mortgage Market," Journal of Financial Services Research, Springer;Western Finance Association, vol. 39(3), pages 145-159, June.

    More about this item

    Keywords

    Interest rates; International topics;

    JEL classification:

    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration

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