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Euro Bonds: In Search of Financial Spillovers

This paper investigates the complexities of Euro bond yields in relation to fiscal policies, focusing on negative spillovers among European nations. It highlights the puzzling divergence in bond yields, especially between Italy and Germany, and assesses the influence of the Stability and Growth Pact (SGP) amid evolving fiscal challenges. With case studies including Germany's reunification and Italy's early '90s fiscal crisis, the study aims to establish a common framework for understanding spillover effects within a highly interconnected European market. Empirical evidence calls for deeper inquiry into the nuances of market discrimination among sovereign issuers.

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Euro Bonds: In Search of Financial Spillovers

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  1. Euro Bonds: In Search of Financial Spillovers Pierre L. Siklos, WLU & VRCME

  2. Negative Spillovers • Should the state of fiscal policy (deficit & debt) have an impact on government bond yields? • The European experience seems either puzzling – Italy and others are not Germany (!) • The European market is one big pool of debt and so small differences ought to persist

  3. Negative Spillovers • Has the SGP played a significant role bond yield developments? What about EMU? • ECB is autonomous and cannot bail-out bad fiscal policies • The SGP has been retooled but hangs on as a disciplining device of sorts

  4. POINTS NOT MADE • Gross public debt rise is an international phenomenon • Bond yields have, until recently, trended down • There is a perceived lack of urgency in dealing with budgetary imbalances

  5. Negative Spillovers: theoretical aspects • 3 institutional pre-conditions: • ECB: strong • SGB: wobbly • No bail-out clause: folk tale? Reality? • Why worry? Can Investors discriminate among different issuers? • Yes: No problem • NO: Contagion or other effects

  6. Negative Spillovers: theoretical aspects • No shortage of hypotheses • Ricardian equivalence • Mundell-Fleming • New Open Economy Macro • Stock vs Flow • Bottom Line: Empirical evidence suggests contradiction and confusion

  7. Negative Spillovers: theoretical aspects • How then to proceed? • Paper: take disparate views and then considers case studies followed by some econometric evidence • Preferred: Set out a kind of common framework that is then testable (e.g., resulting in an SVAR with stock-flow distinction)

  8. From Claeys (2005)

  9. The Case Studies • Germany around reunification (8 pages) • No negative spillovers • Italy’s early 1990s fiscal crisis (3 pages) • Markets can dicriminate

  10. The Case Studies: a closer look • Germany around reunification • Is it relevant? • Is there a reunification Risk Premium? • No explicit role given to what Buba did/said • European business cycle plays secondary role

  11. Some Business Cycles

  12. The Case Studies: a closer look • Germany around reunification • Is it relevant? • Is there a reunification Risk Premium? • No explicit role given to what Buba did/said • European business cycle plays secondary role • Bottom Line: I am still not clear how this is relevant to the main hypothesis of the paper

  13. The Case Studies: a closer look • Italy’s fiscal crisis • Is this relevant? • What about the Exchange rate? Co-mingled with effect we are looking for • Bottom line: Not a true test of what we are looking for

  14. EU’s Track Record

  15. Econometric Evidence • Various bits and pieces of evidence presented. Does it add up? MAYBE but there are many unanswered questions • Why not asymmetry? • Why only levels and not volatility spillovers? • Why so little care in the construction of real yields? • Why the talk about CI when its ignored in the estimation? • Why no attempt at estimating some kind of risk premium?

  16. Econometric Evidence Cont’d • Various bits and pieces of evidence presented. Does it add up? MAYBE but there are many unanswered questions • Granger causality is a problem in CI VARs (Toda and Phillips) • Why not an encompassing approach? • Is Switzerland the right benchmark? • Common EU vs individual country effects need to be clearly delineated • What about the reserve accumulation explanation? (IMF 2006) • What about EU vs New EU members?

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