Fiscal Discipline as a Driver of Sovereign Risk Spread in the European Union Countries

The aim of the paper is to examine if stronger fiscal discipline effects sovereign risk premium in the European Union member states in a period 1990-2011. We understand fiscal discipline as a compliance with targets for budgetary aggregates. We performed estimation on three different panels (EU24, EURO, nonEURO) with the goal to find differences between euro and non-euro countries. We used next variables for testing the impact on sovereign bond spread: German Bunds' interest, budget balance, debt and the fiscal rules index. Correlation analysis identified the strong correlation between sovereign yield spread and budget balance. This is the common trend for all panels. Likewise, fiscal rules index is strong correlated with spread and it is more noticeable in EURO panel. The improvement of fiscal discipline reduces sovereign yield spreads. The biggest difference between panels was found for the debt and German interest rate. These variables are strong correlated only in EURO countries. Surprisingly, there is no correlation in nonEURO and EURO24 panels. We investigated also relationship between spread and fiscal discipline variables using Granger causality methodology. In short-term, there is two-way causality between debt and spread in EURO panel. Findings approved one-way causalities between balance and spread and between yield_de and spread in EU24 and EURO panels; between spread and debt in EU24 and nonEURO panels. Results confirm differences between panels and there is no common pattern of sovereign yield spread determinants in the EU, it is pointing to strong heterogeneity within the EURO and nonEURO countries.