Euro zone: The weight of market discipline

Market discipline has returned to the euro zone since its crisis in 2010-2014: a high fiscal deficit in a country leads to a sharp rise in this country’s long-term interest rates. In the 2010-2014 period, the rise in interest rates was caused by both the external deficit and the fiscal deficit; in the recent period, it has been caused only by the fiscal deficit, as shown by the case of Italy in 2018. The presence of market discipline, even though the ECB’s monetary policy remains highly expansionary, implies that euro-zone countries’ fiscal policies are subject to a major constraint and have to keep the countries fiscally solvent. So an expansionary fiscal policy in the euro zone could be conducted only by: The countries that have significant fiscal leeway (Germany); All the countries, if it goes hand in hand with a monetary policy based on monetisation of all government debt, which cannot exist for an isolated country. Market discipline is now proving to be more powerful than the European rules .