In principle, well-functioning financial markets should reward fiscal prudence and punish unsustainable fiscal policies. It is one of the conundrums of modern-day political economy that, except at times of financial crises, this does not appear to be the case to any great extent. One issue that arises in this context is the extent to which institutional features of financial markets influence such reactions.
In the EMU context, the “no bail-out” clause of the Treaty should encourage financial markets to distinguish between more and less risky sovereign issues. But other institutional features may work in the opposite direction.