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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.

Suggested Citation

  • Thushyanthan Baskaran & Zohal Hessami, 2011. "A Tale of Five PIIGS: Soft Budget Constraints and the EMU Sovereign Debt Crises," Working Paper Series of the Department of Economics, University of Konstanz 2011-45, Department of Economics, University of Konstanz.
  • Handle: RePEc:knz:dpteco:1145
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    File URL: http://www.uni-konstanz.de/FuF/wiwi/workingpaperseries/WP_45-Baskaran-Hessami-11.pdf
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    References listed on IDEAS

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    Cited by:

    1. Mitu Gulati, 2013. "The Evolution of Euro Area Sovereign Debt Contract Terms: A Preliminary Examination," ifo DICE Report, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 11(3), pages 03-09, October.
    2. Wolfinger, Julia & Köhler, Ekkehard, 2017. "The Draghi-Put: When unexpected words on joint liability speak louder than actions," Annual Conference 2017 (Vienna): Alternative Structures for Money and Banking 168265, Verein für Socialpolitik / German Economic Association.
    3. repec:ces:ifodic:v:11:y:2013:i:3:p:19097380 is not listed on IDEAS

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    Keywords

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

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