New Currency, New Constraints? the Euro and Government-financial Market Relations

How does the advent of EMU affect the nature of financial market-government relations? I begin by reviewing the argument that developed-nation governments retain room to move in the face of financial globalization. I then consider the recent implications of EMU for this argument. Membership in EMU restricts governments fiscal and monetary policymaking autonomy, but it also may change their treatment by international capital markets. While interest rates among European government borrowers have converged further since 1999, governments now borrow in what is essentially a foreign currency. This change in sovereign borrowing practices could serve, along with other changes in European financial markets, to heighten the specter of default risk in Europe. The result could be greater interest rate penalties. Along these lines, I investigate whether or not the sorts of financial market pressures faced by European governments are different after EMU and, if so, what the change in pressures implies for contemporary welfare states. Paper prepared for the Year of the Euro conference, University of Notre Dame, December 6-8, 2002. I thank Mariana Sousa for research assistance.