Michael Bergman, University of Copenhagen; Michael M. Hutchison, University of California; Svend E. Hougaard Jensen, Copenhagen Business School
(European Economy. Economic Papers. 489. April 2013.
Brussels. PDF. 62pp. Tab. Bibliogr. Free.)
KC-AI-13-489-EN-N ISBN: 978-92-79-28571-4
This paper discusses the balance between market pressure and fiscal rules in order to keep public finances on a sustainable path. We provide empirical evidence on market assessments of sovereign default risk to economic news, announcements of national austerity programs, EU programs designed to support government finances, and banking fragility emanating from several countries in the euro area affected by the European sovereign debt crisis. We find that, in general, the quality of market signals is an insufficient indicator alone to accurately guide the conduct of fiscal policy, particularly during the crisis period. Therefore, market signals should be used to complement fiscal rules rather than serving as a substitute.