Eurozone Sovereign Debt Research Articles

The Causes, Effects and Countermeasures of the Eurozone Sovereign Debt Crisis: An In-Depth Analysis from the Perspective of Exchange Rate Fluctuations

Since 2009, the eurozone sovereign debt crisis has become the focus of global economic attention. This crisis has not only profoundly affected the economic stability and development of the eurozone, but also had a broad impact on the global financial market. From the perspective of exchange rate fluctuations, this paper will deeply analyze the causes, effects and coping strategies of the eurozone sovereign debt crisis, aiming to provide new perspectives and ideas for understanding the crisis.

Financial Contagion between German and BRICS Stock Markets under Multiscale Scrutiny

We employ wavelet analysis using the maximum overlap discrete wavelet transform (MODWT) to examine the return and volatility interconnectedness between the German equity market (a prominent representative of the Eurozone market) and the BRICS countries over the period 2005–2017. Specifically, we investigate the presence of the pure form of financial contagion in the stock markets of Brazil, Russia, India, China, and South Africa subsequent to the Eurozone Sovereign Debt Crisis (EZDC). Our results indicate the presence of financial contagion between the Eurozone equity market and its counterparts in South Africa and Russia, characterised by co-movement and volatility spillover effects. This contagion is particularly evident at higher frequencies, suggesting that the transmission of shocks occurs rapidly across these markets in the short term. No financial contagion is observed in the Brazilian, Chinese, and Indian stock markets during the European Sovereign Debt Crisis. The absence of financial contagion observed in these three BRICS countries during the European Sovereign Debt Crisis suggests that policymakers in these countries should prioritise addressing idiosyncratic shock channels.

Information Spillovers and Sovereign Debt: Theory Meets the Eurozone Crisis

Abstract We develop a theory of information spillovers in sovereign bond markets in which investors can learn about default risk before trading in primary and secondary markets. If primary markets are structured as multi-unit discriminatory-price auctions, an endogenous winner’s curse leads to strategic complementarities in information acquisition. Shocks to default risk in one country may trigger crisis episodes with widespread information acquisition, sharp increases in the level and volatility of yields in risky countries, low and stable yields in safe countries, market segmentation, and arbitrage profits between primary and secondary markets. These predictions are consistent with the dynamics of auction informativeness during the Eurozone Sovereign Debt Crisis, which we measure using the reaction of secondary market yields to primary market yields.

From Menace to Mundane: Moral Hazard and the Politics of the European Central Bank's Government Bond Purchases

AbstractDuring the Eurozone's sovereign debt crisis, the ideational consensus that shaped the foundation of Economic and Monetary Union (EMU) was destabilized by disagreement on unconventional monetary policies (UMPs), specifically government bond purchases. In the ECB's 2021 strategy review, however, UMPs were confirmed as standard elements of the European Central Bank's (ECB) toolbox. What happened? One argument frequently presented to question the legitimacy of UMPs is that they undermine the prior objective of the EMU of avoiding moral hazard. We analyse the politics of UMPs by focusing upon how top officials in four major Eurozone central banks have discursively constructed the relationship between the ECB's purchase of sovereign debt and moral hazard. We find that top central bank officials aligned to a large degree on the non‐necessary causal relationship between government bond purchases and moral hazard, which reinforced its legitimacy and eventual acceptance as ‘conventional’.

Contagion and linkages across international currencies

This paper examines dynamic linkages among international currencies in the face of several turmoil episodes including the global financial crisis (GFC), eurozone sovereign debt crisis (ESDC) and the recent COVID-19 pandemic. We utilize weekly data from August 2005 till December 2022. Our empirical strategy consists of identification of crisis periods using a Markov-switching VAR, followed by estimation of the dynamic conditional correlations using an ADCC-GARCH model and testing for the impact of the crises using a regression model with robust standard errors. We compare impact of the episodes on the dynamic correlations across the currency pairs. Our findings suggest that correlation between developed economy exchange rates increased significantly during these episodes implying existence of a contagion effect. While significant negative correlation coefficients were observed across all pairs with Japanese Yen during GFC and ESDC, indicating flight to quality. We analyse factors that may be responsible for changes in co-movement of the currencies during the study period and find that financial stress, emergence of the pandemic and geo-political risk have a significant role to play.

The implications of non‐synchronous trading in G‐7 financial markets

AbstractWe investigate the effects of non‐synchronous trading on volatility spillover for the G‐7 equity markets during the Eurozone sovereign debt crisis (ESDC) and the Covid‐19 pandemic crisis. For data synchronisation we utilise ΜΑ(1) adjusted return series to estimate the Baba‐Engle‐Kraft‐Kroner (BEKK) and the dynamic conditional correlation (DCC) models. We also consider the use of realised kernels as explanatory variables in the variance equation. In this set up, the contagion effects during crises periods are more perceptible, as the spikes are easier to interpret. We also check the robustness of our main results by applying, wavelet coherence analysis to G‐7 major equity indices with realised kernels, as well as local Gaussian correlations (LGC). Our findings suggest the empirical significance of the synchronisation effects for the US and the other G‐7 equity markets. We also conclude that realised kernels is an effective tool for mitigating non‐synchronous effects. These results underline the significance of quantifying the synchronisation effects in equity markets as well as international portfolio diversification strategies.

Foreign exchange market return spillovers and connectedness among African countries

This paper examines the foreign exchange return shock spillovers and network connectedness among African countries during crisis periods using (Diebold & Yilmaz, 2012; 2014; 2016) which is based on generalized VAR and network theory between June 2004 and June 2021. Overall, the study found a low system-wide spillover connectedness among African foreign exchange markets. However, the total systemic spillover index increased during the eurozone sovereign debt crisis followed by global financial crisis, indicating evidence of contagion effects. This offers good diversification opportunities in the African currency market during crisis periods. The study also found no significant evidence of spillover effects among African currencies. Nonetheless, the network connectedness analysis found a positive significant pairwise return spillovers from the South African rand, Moroccan dirham and the CFA francs to Botswana pula, and from Moroccan dirham to CFA francs and South African rand. Furthermore, the study found South African rand, Moroccan dirham and CFA francs as the most significant net-transmitter of return shocks to other currencies whiles the Kenyan shilling and Botswana pula are the net-receivers of return shocks from other currencies. These results have implications for African central banks interventions in stabilizing their exchange rates to facilitate intra and inter-African trade and for international portfolio investors in managing their foreign exchange risk exposures.

Boundary objects in complex governance systems: collective action clauses in European sovereign debt governance

ABSTRACT This contribution argues that policymakers instrumentalise legal ambiguity to provide solutions to crises and achieve their preferences in complex governance systems. It looks at the Eurozone crisis and the introduction of sovereign debt restructuring as part of the policy solution. Despite initial opposition from the European Central Bank (ECB) and European Commission (EC), as well as negative market reactions, Greece’s debt was restructured in 2012. The notion of collective action clauses (CACs)—a private contractual term in bond documentation that enables bondholder coordination—was promoted as the credible tool for enabling sovereign debt restructuring. However, this paper argues that the success of CACs is related to how it functions as a boundary object, enabling a shared space of interpretive flexibility that allows policymakers to interpret CACs in terms of their preferences, despite a lack of consensus on the permissibility of future Eurozone sovereign debt restructurings. While enabling cooperation, this interpretive flexibility leads to different iterations of CACs—the Euro-CAC and Greece’s retrofit-CAC—which connects EU fiscal policy to monetary policy in a way that induces legal uncertainty as to the viability of future debt restructurings vis-à-vis the ECB’s bond-buying programmes.

On the international co-movement of natural interest rates

Using quarterly data for 10 OECD countries and the Euro area and a Kalman filtering technique, we investigate the international co-movement among natural interest rates. We show that the US is the main source of global spillovers and global/common factors appear to be key drivers of such co-movement. Indeed, global liquidity is a net transmitter of shocks, while quantitative easing (QE) and the US Dollar are net recipients of shocks. We also find that total spillovers among natural interest rates have been rising since the late nineties, spiking at around economic recessions, periods of US monetary policy tightening, the global financial crisis and the Eurozone sovereign debt crisis. From a policy perspective, our findings suggest: (i) the need of more monetary policy coordination among countries to tackle common drivers of natural rates; (ii) the importance of complementing monetary policy with macro-financial stabilisation tools to ease the global constraints that it faces; (iii) a very gradual and uncertain monetary normalisation path, subject to spikes in financial markets' volatility; and (iv) a (lower) “new normal” level for real policy rates.

EUROZONE SOVEREIGN DEBT CRISIS AND ITS IMPACT ON INDIA'S CROSS-BORDER CREDIT MARKET

This study examines the impact of the Eurozone's sovereign debt crisis on cross-border credit to India, addressing: (i) Causes of subsided lending, (ii) India's loan demand, (iii) Influence of Eurozone banks' home countries on credit, and (vi) Identification of the banking system responsible for the falloff. Results indicate that a 1% change in India's sovereign debt to GDP ratio is linked to a $1013m increase in cross-border lending from the Eurozone. A 1% change in the Eurozone's ratio is associated with a $556m increase in cross-border credit to India. A 1% rise in India's real GDP growth rate is associated with a $164m increase in cross-border bank financing to India. The results indicate that global banks propagate financial shocks from their country of origin. The implications suggest that the concentration of cross-border credit in advanced economy financial systems puts emerging economies like India at risk of country- or region-specific financial shocks.

Fit and Proper Requirements in the EU Banking Sector. A Step Further

Prudential regulation has become increasingly important over time. In such a context, strict suitability requirements for members of the management body and key function holders are considered an adequate tool to safeguard the sound and prudent management of banks. In the years following the Great Financial Crisis in 2008–2009 and the Eurozone sovereign debt crisis in 2010–2012, the regulatory and supervisory approach to banks’ corporate governance has seen a significant evolution. The centralisation of banking supervision at the Eurozone level was complemented by the application of a single rulebook throughout the European Union which stated, in compliance with the Capital Requirements Directive, higher suitability requirements for being appointed as a member of a management body or as a key function holder at a bank. Furthermore, the choice to identify fit and proper requirements through standards attributes significant power to the decision maker, thus allowing greater public control over private choices, and is justified by the need to prevent negative externalities. This approach is open to debate. Against the background of the pursuit of public interest, the lawmaker confers discretionary power on the supervisory authorities (the European Central Bank and the national competent authorities), and sets restrictions on the job market for board member candidates. This paper is a contribution enriching the ongoing discussion about the existing regulatory and policy regime, with a special focus on the specific functions performed by the management body members and particularly by the chairs of the management body’s special committees.

Testing Financial Contagion in Emerging Countries: Evidence From BRICS Countries

This study uses a Multivariate Generalised Autoregressive Conditional Heteroskedasticity (MGARCH) model to examine the pure form of financial contagion in BRICS countries (Brazil, Russia, India, China, and South Africa) in the wake of two major international financial crises namely the U.S. sub-prime and Eurozone sovereign debt crises (EZDC). The pure form of contagion refers to the spread of shocks that are unrelated to macroeconomic fundamentals and are simply the product of irrational phenomena like panics, herd behaviour, loss of confidence, and risk aversion. To investigate contagion the present study analyses the pairwise dynamic cross-correlation between the US and Eurozone equity markets as ‘source’ (ground zero) markets and individual BRICS stock markets as ‘target’ markets.For the each of the two crises that are examined the sets of data used, were divided into two sub-periods (1) the crisis period and (2) the stable period. For the Sub-prime crisis, the findings of the present study indicate the presence of cross-conditional volatility between the US and BRICS stock markets. The results also showed that the cross-conditional volatility coefficient is high in magnitude during periods of financial upheaval compared to a tranquil period, hence the conclusion that there was financial contagion during in BRICs stock markets (except in Chinese market) following the U.S. sub-prime crisis. As for the EZDC, equity markets in Brazil, India and China seemed to react equally (in both the ‘crisis’ and ‘post-crisis’ periods) from shocks emanating from European equity market. Hence the conclusion that there was no contagion in Brazil, India and China following the Eurozone sovereign debt crisis.

Financial and trade relationships between the Eurozone and China in the age of resilience

How did the financial and trade ties between China and the Eurozone develop in the aftermath of the Eurozone sovereign debt crisis? We analyze these trends until the start of the COVID-19 pandemic. Using data from the Bank of International Settlements (BIS) and the International Monetary Fund (IMF), we examine the financial and trade dynamics between the two currency areas and analyze the related risks and opportunities. The data point to several patterns. We find that financial volatility in China has been substantially greater than in the Eurozone. Even so, the largest and strongest Eurozone economies—France and Germany—have largely kept their investments in Chinese assets after a four- to sixfold expansion that started in the mid-2000s. In contrast, the financially weakest countries have accounted for the largest increases in trade volumes between China and the Eurozone. We also find that trade volumes are correlated with holdings of Chinese financial assets but assets rose at a substantially smaller rate than trade. These results show that China and the Eurozone continue to be asymmetrically integrated, whereby Eurozone countries still invest more timidly in Chinese financial assets compared to the aggressive trade and infrastructure partnerships initiated by China. We discuss the implications for future financial and trade integration between the two currency areas, which is bound to deepen in light of the Comprehensive Agreement on Investment.

The IRB model, bank regulatory arbitrage, and the Eurozone crisis

By using a novel dataset on bank-level exposures to specific countries, I investigate how model-based capital regulations can be misused by European banks for capital saving purposes during the Eurozone sovereign debt crisis. I find that relative to banks from core countries, banks from peripheral countries (1) could greatly reduce the risk-weight of their assets in capital requirement calculations by applying more model-based capital rules, and (2) that the default frequency of their assets is not properly reflected in their capital requirement calculations. These results indicate that banks from peripheral countries are more likely to conduct regulatory arbitrage against model-based capital rules.

Banks and sovereigns: did adversity bring them closer?

We analyse the stability of the cross-market shock transmission mechanism between banks and sovereign bonds during the Eurozone sovereign debt crisis for crisis-hit periphery countries and Germany. We also examine the shock propagation of banking shocks and sovereign bond shocks between domestic and external markets. Using a Markov-switching framework, we find strong evidence of bilateral contagion between banks and sovereign bonds and also between domestic and external banking sectors. Sovereign bond markets are different. An external shock only produces contagious effects in Greece, who were largely dependent on external aid. For all the others, external shocks lead to decoupling as investors became increasingly discerning in their perception of the debt instruments issued by different Eurozone states.

Failed Attempt to Break Up the Oligopoly in Sovereign Credit Rating Market after Financial Crises

For decades, the credit rating market has been dominated by three major agencies (Moody's, S&P and Fitch Ratings). Their oligopolistic dominance is especially strong in sovereign credit ratings industry, where they hold a collective global share of more than 99%. Global financial crisis and the Eurozone sovereign debt crisis exposed serious flaws in rating process and forced public authorities to act. This study investigates effectiveness of new regulations adopted in the United States and in the European Union after financial crises in terms of reducing oligopolistic dominance of the “Big Three” in sovereign credit ratings market. The study applies descriptive statistical analysis of economic indicators describing concentration rate in a market, as well as content analysis of legal acts and case study methodology. Analysis shows that the Dodd-Frank reform and new European rules on supervision of credit rating agencies were not effective enough and did not lead to the increased competition in the market. The evidence from this study is explained using two alternative perspectives – economic theory of natural oligopoly and hegemonic stability theory coming from international relations field.

The Taylor curve: international evidence

ABSTRACT We use the Taylor curve to gauge deviations of monetary policy from an efficiency locus for the United Kingdom (UK) and the four largest economies of the Eurozone (Germany, France, Italy, Spain) for the period 2000–2018. For this purpose, we use shadow interest rates, which is a common metric for both conventional and unconventional monetary policies, and the newly proposed Hamilton-filter to measure output gap, which improves upon the drawbacks of the traditionally used Hodrick–Prescott filter. Our findings suggest that deviations in the UK mostly occurred amid the global financial crisis and the post-Brexit period, whereas Eurozone members experienced more volatile deviations around 2001, during the global financial crisis and the Eurozone sovereign debt crisis.

Unconventional Monetary Policy and Auction Cycles of Eurozone Sovereign Debt

AbstractWe provide evidence that the European Central Bank (ECB's) unconventional monetary policy dampens yield cycles in secondary markets for Eurozone sovereign debt around new sovereign debt auctions. This dampening effect tends to be larger when market volatility is higher. Cycles caused by domestic auctions and the role of market volatility are largest for countries with low credit ratings. Auctions by these countries also generate significant auction cycles in other countries. Such cycles can have a nonnegligible effect on debt‐servicing costs, but these can be limited through central bank purchases in turbulent periods, debt issuance in tranquil periods, and coordination of national auction calendars.

Nein to ‘Transfer Union’: the German brake on the construction of a European Union fiscal capacity

ABSTRACT This paper argues that, on the development of European Union (EU)/Eurozone fiscal capacity German governments have consistently engaged in foot-dragging. Few German state elites have ever supported European fiscal capacity building beyond the EC budget. Following the outbreak of the Eurozone sovereign debt crisis, German governments agreed to the creation of financial support mechanisms only with reluctance. We see a case of continuity in German policy preferences driven by consistent ordoliberal and, specifically, moral hazard concerns. The important long-term change that we can observe relates to the growing importance for successive governments of avoiding audience costs driven by sceptical public opinion and the rise of a challenger party in German politics. German government support for a massive EU fiscal response to the economic crisis triggered by the COVID-19 pandemic demonstrates an exceptional policy position in favour of temporary financial mechanisms involving no fiscal transfers among member state governments.

Reassessing External Images of the EU: Evolving Narratives in Times of Crisis

The past decade has challenged the EU and its international image. The Eurozone sovereign debt crisis, the Ukraine crisis, the so-called irregular migration crisis and the Covid-19 pandemic have all put the EU under severe strain. This article explores if and how the EU’s performance in such crises has impacted upon the external image of the EU. The analysis shows that external images have closely followed the EU’s actual performance, although filtering it through the powerful lenses of local and regional concerns and sensibilities. While some traditional images have proved to be resilient in the longer run (as in the case of the EU as an economic powerhouse or a frequently divided community), others have been severely weakened by the EU’s crisis responses (such as the EU as a bastion of human rights). Our findings contribute to the discussion on the public diplomacy and information strategy of the European External Action Service (EEAS) in shaping locally-resonating positive images of the EU worldwide. external images of the EU, multiple crises of the EU, EU public diplomacy