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The role of uncertainty in the euro crisis – an application of liquidity preference theory

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  • Toralf Pusch

Abstract

The world financial crisis triggered a rediscovery of the active role fiscal policy can play as a remedy in such situations. During the euro crisis, escalating funding costs in a number of southern eurozone member states and Ireland have called this strategy into question. One interpretation of the euro crisis concentrated on the public debt trends in those countries. Opposing this view, the main point of this contribution is to elaborate the link between rising interest rates on sovereign bonds in the euro crisis and a major feature of the financial crisis – a subdued degree of investor confidence after the Lehman collapse. Theoretically, this link is developed with reference to Keynes’ liquidity preference theory. The high explanatory power of measures for the degree of confidence in financial markets as well as detrimental effects of fiscal austerity on the evolution of sovereign yield spreads are demonstrated empirically by means of panel regressions and supplementary correlation analyses.

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  • Toralf Pusch, 2017. "The role of uncertainty in the euro crisis – an application of liquidity preference theory," International Review of Applied Economics, Taylor & Francis Journals, vol. 31(4), pages 527-548, July.
    • Handle: RePEc:taf:irapec:v:31:y:2017:i:4:p:527-548
    DOI: 10.1080/02692171.2016.1271975
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