The discipline of Financial Markets

John Kay writes an interesting article on the FT today about the limited effect of fiscal rules on fiscal discipline. This is related to out last blog entry and I agree with most of his arguments although I am less pessimistic, there are some fiscal rules that work better than others. What I found surprising is one of the last sentences in his article (a sentence that was highlighted in the title of the article):

Financial markets are an effective discipline on profligate individuals and states because markets cannot easily be bullied or lobbied, and their threat to make the cost of funds prohibitive is effective.

Financial markets are NOT effective when it comes to providing discipline to governments. Yes, occasionally they do bring governments down and they push governments that misbehave towards default, but they do so in the last minute. They are completely absent in the years where discipline could really matter, when things go well and governments should work hard at generating a large surplus. This is the experience of European countries since the launch of the Euro when all governments were seen as identical and their bonds were priced as risk-free assets. Where was the discipline of financial markets then?

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About Antonio Fatás 136 Articles

Affiliation: INSEAD

Antonio Fatás is professor of Economics at INSEAD. He is a Research Fellow at the Centre for Economic and Policy Research in London and has worked as external consultant for international organizations such as the International Monetary Fund, the OECD and the World Bank.

He teaches the macroeconomics core course in the MBA program as well as different modules on the global macroeconomic environment in Executive Education. His research is focused on the study of business cycles, fiscal policy and the economics of European integration. His articles appear in academic journals such as the Quarterly Journal of Economics, Journal of Monetary Economics, Journal of Money, Credit and Banking, Journal of Public Economics, Journal of International Economics, Journal of Economic Growth, European Economic Review or Economic Policy.

Professor Fatás earned his M.A. and Ph.D. from Harvard University, and M.S. from Universidad de Valencia.

Visit: INSEAD

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