Self-Fulfilling Crises in the Eurozone: An Empirical Test

40 Pages Posted: 24 May 2012

See all articles by Paul De Grauwe

Paul De Grauwe

CESifo (Center for Economic Studies and Ifo Institute for Economic Research); London School of Economics & Political Science (LSE); Centre for Economic Policy Research (CEPR)

Yuemei Ji

KU Leuven - Faculty of Business and Economics (FEB)

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Date Written: May 24, 2012

Abstract

We test the hypothesis that the 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 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.

Keywords: Eurozone, multiple equilibria, self-fulfilling crises

JEL Classification: F000

Suggested Citation

De Grauwe, Paul and De Grauwe, Paul and Ji, Yuemei, Self-Fulfilling Crises in the Eurozone: An Empirical Test (May 24, 2012). CESifo Working Paper Series No. 3821, Available at SSRN: https://ssrn.com/abstract=2065711 or http://dx.doi.org/10.2139/ssrn.2065711

Paul De Grauwe (Contact Author)

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

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Germany

London School of Economics & Political Science (LSE) ( email )

Houghton Street
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Centre for Economic Policy Research (CEPR)

London
United Kingdom

Yuemei Ji

KU Leuven - Faculty of Business and Economics (FEB) ( email )

Naamsestraat 69
Leuven, B-3000
Belgium

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