A lower level of risk premium decreases the refinancing cost of the existing debt stock thus enhances fiscal sustainability while it decreases the cost of capital which has a beneficial effect on potential output through higher investments. Lower risk premium can lead to exchange rate appreciation and in a competing banking system decreases lending rates.
Looking ahead, a down-turn in the US macro-financial cycle could trigger a correction in markets in particular for riskier asset classes. Furthermore, tensions have grown in emerging market economies on the back of a stronger US dollar and increased trade frictions. These developments may undermine global growth prospects and ultimately lead to abrupt increases in risk premia.