Does market discipline enter governments' fiscal reaction functions in the euro area?

This section assesses the role that markets have played in disciplining governments’ behaviour across the euro area since the euro was launched. Discipline is measured by market interest rates, while governments’ behaviour is measured by adjustments in primary budget balances. Using real-time data derived from DG ECFIN’s forecast vintages released between 2002 and 2018 this section assesses the fiscal response of governments to changes in interest rates, conditioned by a variety of factors such asthe maturity composition of public debt and other country characteristics. The main finding is that bond markets exerted limited pressure on sovereign issuers in the run-up to the crisis. In contrast, during the crisis and afterwards Member States recorded a notable adjustment in their primary balances in response to interest rates soaring; this adjustment was more noticeable in those countries hardest hit by the crisis. The econometric analysis also suggests that the EU fiscal framework (e.g. national fiscal councils), the maturity structure of public debt and parliamentary elections have been significant factors affecting this responsiveness of fiscal policies.