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Do Fundamentals Explain Differences between Euro Area Sovereign Interest Rates?

Stéphanie Pamies, Nicolas Carnot and Anda Pătărău

No 141, European Economy - Discussion Papers 2015 - from Directorate General Economic and Financial Affairs (DG ECFIN), European Commission

Abstract: This paper explores the determinants of sovereign interest rate spreads of euro area countries (vis-à-vis Germany), using panel regressions with annual data for 2000-2019. It focuses on the role of fundamental factors, namely fiscal, macroeconomic and institutional variables, while considering also some contextual factors such as global risk aversion and controlling for the influence of central banks’ asset purchases. Through extensive testing of various (fiscal) variables, interactions and non-linearities, the analysis confirms that sovereign spreads respond to fundamental variables, especially the government debt, indicating that such response is non-linear. The results also show that structural factors, such as potential growth and the quality of institutions, can largely mitigate the impact from government debt on spreads. Indeed, in countries with the highest potential growth and strongest institutions, the marginal effect of government debt on spreads would be close to zero. From a policy angle, the results are a reminder that, even in an environment of persistently low rates, more solid fundamentals allow governments to benefit from lower borrowing costs and lessrisk exposure. They also highlight that policies aimed at reinforcing potential growth and government effectiveness can be expected to improve investors’ perception of sovereign risk and their forbearance of higher debt.

JEL-codes: C23 E43 E62 H63 O52 (search for similar items in EconPapers)
Pages: 52 pages
Date: 2021-06
New Economics Papers: this item is included in nep-cwa, nep-eec, nep-fdg and nep-mac
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