Fiscal Discipline and the Question of Convergence of National Interest Rates in the European Union

In this paper, interest-rate convergence in Europe is related to the behavior of integrated federal political systems. Our main results are: Before the final fixing of exchange rates, national interest rates will converge toward the German bond yield in countries eligible to become EMU members in part because no-bailout clauses are not credible in the starting period of EMU. Should such clauses become more credible after 2002 because the EU government and its redistributive mechanisms remain weak, the market-discipline hypothesis has a greater chance to apply. But it may still prove unequal to the task of discouraging excessive fiscal deficits on its own.