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Mispricing of Sovereign Risk and Multiple Equilibria in the Eurozone. CEPS Working Document No. 361, January 2012

De Grauwe, Paul. and Ji, Yuemei (2012) Mispricing of Sovereign Risk and Multiple Equilibria in the Eurozone. CEPS Working Document No. 361, January 2012. [Working Paper]

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    Abstract

    This paper finds evidence that a significant part of the surge in the spreads of the PIGS countries (Portugal, Ireland, Greece and Spain) in the eurozone during 2010-11 was disconnected from underlying increases in the debt-to-GDP ratios, and was the result of negative market sentiments that became very strong since the end of 2010. We also find evidence that after years of neglecting high government debt, investors became increasingly worried about this in the eurozone, and reacted by raising the spreads. No such worries developed in stand-alone countries despite the fact that debt-to-GDP ratios were equally high and increasing in these countries. We interpreted this evidence as validating the hypothesis formulated in De Grauwe (2011) according to which government bond markets in a monetary union are more fragile and more susceptible to self-fulfilling liquidity crises than in stand-alone countries. We argue that the systematic mispricing of sovereign risk in the eurozone intensifies macroeconomic instability, leading to bubbles in good years and excessive austerity in bad years.

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    Item Type: Working Paper
    Subjects for non-EU documents: Countries > Greece
    Countries > Ireland
    Countries > Portugal
    Countries > Spain
    EU policies and themes > Policies & related activities > economic and financial affairs > EMU/EMS/euro
    EU policies and themes > Policies & related activities > economic and financial affairs > economic policy
    EU policies and themes > Policies & related activities > economic and financial affairs > financial crisis 2008-on and consequences/reforms
    Subjects for EU documents: UNSPECIFIED
    EU Series: UNSPECIFIED
    ["eprint_fieldname_eusries" not defined]: UNSPECIFIED
    EU Annual Reports: UNSPECIFIED
    Series: Series > Centre for European Policy Studies (Brussels) > CEPS Working Documents
    Depositing User: Phil Wilkin
    Official EU Document: No
    Language: English
    Date Deposited: 25 Jan 2012 10:18
    Number of Pages: 22
    Last Modified: 25 Jan 2012 10:18
    URI: http://aei.pitt.edu/id/eprint/33373

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