Assessing the Pre-Crisis Advantages of the EMU for Sovereign Debt Issuers: a Panel VAR Analysis

In this paper we study the relationship between public debt and the real long-term interest rates in the countries currently members of the European Monetary Union (EMU) to assess the long-run macroeconomic performance of the single currency. We employ a panel VAR method using annual data from 1970 to 2008, leaving out of the analysis the European sovereign debt crisis due to the fact that this is an ongoing phenomenon. We find that before the introduction of the euro different levels of public debt affected the responses of the interest rates to debt shocks, with larger effects in high-debt countries relatively to low-debt ones. On the other hand, the inclusion of the EMU years shows the stabilizing role played by the monetary union in insulating the interest rates from domestic fiscal developments.