Debt and punishment: Market discipline in the Eurozone

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This article challenges the conventional wisdom of weak market discipline in Economic and Monetary Union (EMU). In so doing, we empirically analyse the dynamics of market disci-pline for all 27 EU member states between 1992 and 2007. The existing literature tends to assert that markets discipline governments, without measuring whether the interest punish-ment markets impose actually have the purported effect on government policy. To better grasp the dynamics of market discipline it is essential to consider both sides. Market disci-pline is thus understood as a two-sided phenomenon. On the one hand, financial investors react to policy developments. On the other hand, policy-makers react to market signals. We find strong evidence that although the impact of fiscal policy developments on market pun-ishment slightly decreases with monetary integration, government responsiveness to market punishment increases. This runs counter to the conventional narrative of policy-makers bank-ing on bail-out from fellow EMU members.
Original languageEnglish
Pages (from-to)752-782
JournalNew Political Economy
Issue number5
Early online date23 Feb 2015
Publication statusPublished - 3 Sep 2015

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