Convergence of Government Bond Yields in the Euro Zone: The Role of Policy Harmonization

Denise Côté () and Christopher Graham

Staff Working Papers from Bank of Canada

Abstract: Since the early 1980s, long-term government bond yields in the euro zone have declined, in line with those in other industrialized countries. In this paper, the authors examine the monetary and fiscal policies adopted by European countries on the path to Economic and Monetary Union (EMU), and assess how these policies, including the introduction of the common currency, have contributed to the convergence of national long-term government bond yields in the euro zone. The authors find evidence that increased harmonization of monetary and fiscal policies on the path to EMU contributed greatly to the convergence of long-term government bond yields in the euro zone. More importantly, their findings suggest that the convergence of national long-term government bond yields in the euro zone cannot be attributed primarily to the introduction of the common currency itself, since two control groups of other OECD countries experienced a similar convergence. The first control group consists of other European Union (EU) countries not included in EMU (Denmark, Sweden, and the United Kingdom), and the second group includes other OECD countries that are members of neither EMU nor the EU (Australia, Canada, Norway, and Switzerland). The authors also find evidence that currency risk premiums declined gradually following the adoption of the Maastricht Treaty and were largely eliminated by the time the single currency was introduced in January 1999. These findings suggest that, in the context of integrated international financial markets, harmonization of sound monetary and fiscal policies across countries will cause national long-term bond yields to converge. Based on evidence from the euro zone, the adoption of a common currency will have, at most, a secondary effect on the convergence of national bond yields.

Keywords: Interest rates; International topics (search for similar items in EconPapers)
JEL-codes: C23 E43 E44 F36 (search for similar items in EconPapers)
Pages: 67 pages
Date: 2004
New Economics Papers: this item is included in nep-fin, nep-ifn and nep-mon
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Citations: View citations in EconPapers (10)

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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:04-23

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