A not so delicate sound of Europeanness : European fiscal policy events and the euro-dollar risk premium

Abstract

Although the European Monetary Union (EMU) is mainly an economic institution, its future has always hinged upon political manoeuvres. This article examines whether and to what extent non-scheduled and scheduled political events concerning the fiscal governance framework of the EMU have influenced foreign exchange markets. In particular, we estimate how decisions made by the European Commission, the Economic and Financial Affairs Council and the European Council affected the systematic euro-dollar risk premium. Analysing daily data from 2001 to 2005 with a Component GARCH model, we show how the political rhetoric and action have influenced financial markets. Our empirical results highlight crucial shortcomings of the fiscal policy framework of the EMU.