Pandemic Shocks and Fiscal-Monetary Policies in the Eurozone: Covid-19 Dominance During January - June 2020

42 Pages Posted: 29 Jun 2020 Last revised: 23 Jun 2021

See all articles by Yothin Jinjarak

Yothin Jinjarak

Victoria University of Wellington - School of Economics & Finance

Rashad Ahmed

University of Southern California - Department of Economics

Sameer Nair-Desai

University of Southern California

Weining Xin

Department of Economics

Joshua Aizenman

University of Southern California - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: June 2020

Abstract

We compare the importance of market factors against that of COVID-19 dynamics and policy responses in explaining Eurozone sovereign spreads. First, we estimate a multifactor model for changes in credit default swap (CDS) spreads over January 2014 - June 2019. Then, we apply a synthetic control-type procedure to extrapolate model-implied changes in the CDS. The factor model does very well over the rest of 2019 but breaks down during the pandemic, especially during March 2020 when there is a large divergence between the actual and model-implied CDS changes. We find that the March 2020 divergence is well accounted for by COVID-specific risks and associated policies, mortality outcomes, and policy announcements, rather than traditional determinants. Daily CDS widening ceased almost immediately after the ECB announced the PEPP, but the divergence between actual and model-implied changes persisted. This points to COVID-19 Dominance: widening spreads during the pandemic has led to unconventional monetary policies that primarily aim to mitigate short-run fears, temporarily pushing away concerns over fiscal risk.

Suggested Citation

Jinjarak, Yothin and Ahmed, Rashad and Nair-Desai, Sameer and Xin, Weining and Aizenman, Joshua, Pandemic Shocks and Fiscal-Monetary Policies in the Eurozone: Covid-19 Dominance During January - June 2020 (June 2020). NBER Working Paper No. w27451, Available at SSRN: https://ssrn.com/abstract=3637753

Yothin Jinjarak (Contact Author)

Victoria University of Wellington - School of Economics & Finance ( email )

P.O. Box 600
Wellington 6001
New Zealand

Rashad Ahmed

University of Southern California - Department of Economics ( email )

3620 South Vermont Ave. Kaprielian (KAP) Hall, 300
Los Angeles, CA 90089
United States

Sameer Nair-Desai

University of Southern California

Weining Xin

Department of Economics

3620 S Vermont Ave, KAP300
Los Angeles, CA California 90089
United States

Joshua Aizenman

University of Southern California - Department of Economics ( email )

3620 South Vermont Ave. Kaprielian (KAP) Hall, 300
Los Angeles, CA 90089
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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