MARKET POWER AND BANK INTEREST RATE ADJUSTMENTS - Documentos de Trabajo N.º 0539

The different views presented in the previous section suggest different aspects of how the SGP could affect capital market expectations about future developments, and hence prices for fixed government securities. If a strict interpretation of the SGP reduces budgetary flexibility and short-term growth prospects, it might lead to lower short or medium term interest rates. Conversely, if the central bank considers any breach or lax implementation of the Pact as an indication of an unduly expansionary fiscal policy leading to higher inflation, it could foreclose a monetary easing. Institutional strictness could then be conducive to lower short or medium-term rates. Finally, if the default risk premium prevails, this...