Lender of Last Resort, Buyer of Last Resort, and a Fear of Fire Sales in the Sovereign Bond Market
67 Pages Posted: 12 Apr 2016 Last revised: 28 Dec 2020
Date Written: December 23, 2020
We document the mechanism through which the risk of fire sales in the sovereign bond market contributed to the effectiveness of two major central bank interventions designed to restore financial stability during the European sovereign debt crisis. As a lender of last resort via the long-term refinancing operations (LTROs), the European Central Bank (ECB) improved the collateral value of sovereign bonds of peripheral countries. This resulted in an elevated concentration of these bonds in the portfolios of domestic banks, increasing fire-sale risk and making both banks and sovereign bonds riskier. In contrast, the ECB’s announcement of being a potential buyer of last resort via the Outright Monetary Transaction (OMT) program attracted new investors and reduced fire-sale risk in the sovereign bond market.
Keywords: Bank-sovereign nexus, ECB, financial stability, unconventional monetary policy
JEL Classification: G01, G21, G28
Suggested Citation: Suggested Citation