Yields on Sovereign Debt, Fragmentation and Monetary Policy Transmission in the Euro Area: A GVAR Approach

32 Pages Posted: 11 Feb 2017

See all articles by Victor Echevarria-Icaza

Victor Echevarria-Icaza

Universidad Complutense de Madrid (UCM)

Simon Sosvilla-Rivero

UCM Institute for Economic Analysis

Date Written: February 10, 2017

Abstract

The divergence in sovereign yields has been presented as a reason for the lack of traction of monetary policy. We use a GVAR framework to assess the transmission of monetary policy in the period 2005-2016. We identify sovereign yield divergence as a key mechanism by which the leverage channel of monetary policy worked. Unconventional monetary policy was successful in mitigating this effect. When exploring the channels through which yields may affect the heterogeneous transmission of monetary policy, we find that the reaction of bank leverage depended substantially on where the sovereign yield originated, thus providing a mechanism that explains this heterogeneity. Second, large spillover effects meant that yield divergence decreased the traction of monetary policy even in anchor countries. Third, the heterogeneity in the transmission mechanism can be in part attributed to contagion from euro-area wide sovereign stress. Fiscal credibility, therefore, may be an appropriate tool to enhance the output effect of monetary policy. Given the importance of spillovers, this credibility may be achieved by changes in the institutional make-up and policies in the euro area.

Keywords: monetary policy, spillovers, euro area crisis

JEL Classification: E52, E63, F45, H63

Suggested Citation

Echevarria-Icaza, Victor and Sosvilla-Rivero, Simon, Yields on Sovereign Debt, Fragmentation and Monetary Policy Transmission in the Euro Area: A GVAR Approach (February 10, 2017). Available at SSRN: https://ssrn.com/abstract=2915177 or http://dx.doi.org/10.2139/ssrn.2915177

Victor Echevarria-Icaza

Universidad Complutense de Madrid (UCM) ( email )

Carretera de Humera s/n
Madrid, Madrid 28223
Spain

Simon Sosvilla-Rivero (Contact Author)

UCM Institute for Economic Analysis ( email )

Carretera de Humera s/n
Madrid, Madrid 28223
Spain
+34913932626 (Phone)

HOME PAGE: http://www.ucm.es/info/ecocuan/ssr/

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