Playing the market or played by the markets? Financial market discipline and public debt management in the EU

One of the great unresolved puzzles of political economy is why governments have limited their capacity to raise debt and to intervene in markets at their discretion to the extent they did over the last three decades. Especially in the European Union, governments subjected themselves to fiscal rules and an unprecedented degree of transparency in their budgetary policies. These ‘good governance’ devices do not necessarily constrain fiscal policies directly as the repeated violation of the Stability and Growth Pact indicates. But the financial crisis showed that transparency about contingent liabilities and the dependence on private credit ratings for bonds that the ECB accepts at the discount window expose fiscal authorities to sudden stops of capital flows. The paper reviews first the evidence for market discipline on public debt management. It explores, second, to what extent EU governments came to embrace financial market discipline in their public debt management. Finally, it asks why governments let this happen, rhetorically or pragmatically.