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Self-Fulfilling Crises in the Eurozone: An Empirical Test. CEPS Working Document No. 366, 22 June 2012

De Grauwe, Paul. and Ji, Yuemei (2012) Self-Fulfilling Crises in the Eurozone: An Empirical Test. CEPS Working Document No. 366, 22 June 2012. [Working Paper]

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    Abstract

    This paper tests the hypothesis that government bond markets in the eurozone are more fragile and more susceptible to self-fulfilling liquidity crises than in stand-alone countries. We find 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 fiscal space variables, and was the result of negative self-fulfilling market sentiments that became very strong since the end of 2010. We argue that this can drive member countries of the eurozone into bad equilibria. 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 and fiscal space variables were equally high and increasing in these countries.

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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 > Single Market > capital, goods, services, workers
    EU policies and themes > Policies & related activities > economic and financial affairs > financial crisis 2008-on/reforms/economic governance
    Subjects for EU documents: UNSPECIFIED
    EU Series and Periodicals: 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 Jun 2012 22:12
    Number of Pages: 29
    Last Modified: 25 Jun 2012 22:12
    URI: http://aei.pitt.edu/id/eprint/35633

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