Publication

This paper tests the hypothesis that government bond markets in the eurozone are more fragile and more susceptible to self-fulfilling liquidity crises than those in ‘stand-alone’ countries, i.e. countries that issue debt in their own currencies. The authors 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, but rather was the result of negative self-fulfilling market sentiments that became very strong starting at the end of 2010. The authors argue that this phenomenon can drive member countries of the eurozone into bad equilibria.