Emu Deepening and Sovereign Debt Spreads: Using Political Space to Achieve Policy Space

67 Pages Posted: 10 Feb 2021

See all articles by Iván Kataryniuk

Iván Kataryniuk

Banco de España

Víctor Mora-Bajén

Banco de España

Javier J. Pérez

Banco de España - Research Department

Date Written: January 19, 2021

Abstract

Sovereign spreads within the European Monetary Union (EMU) arise because markets price-in heterogeneous country fundamentals, but also re-denomination risks, given the incomplete nature of EMU. This creates a permanent risk of financial fragmentation within the area. In this paper we claim that political decisions that signal commitment to safeguarding the adequate functioning of the euro area influence investors’ valuations. We focus on decisions conducive to enhancing the institutional framework of the euro area (“EMU deepening”). To test our hypothesis we build a comprehensive narrative of events (decisions) from all documents and press releases issued by the Council of the EU and the European Council during the period January 2010 to March 2020. We categorize the events as dealing with: (i) economic and financial integration; (ii) fiscal policy; (iii) bailouts. With our extremely rich narrative at hand, we conduct event-study regressions with daily data to assess the impact of events on sovereign bond yields and find that indeed decisions on financial integration drive down periphery spreads. Moreover, while decisions on key subjects present a robust effect, this is not the case with prior discussions on those subjects at the Council level. Finally, we show that the impacts arise from reductions in peripheral sovereign spreads, and not by the opposite movement in core countries. We conclude that EU policy-makers have at their disposal significant “political space” to reduce fragmentation and gain “policy space”.

Keywords: Euro area, EU integration, sovereign spreads, financial fragmentation

JEL Classification: E44, F36, G14

Suggested Citation

Kataryniuk, Iván and Mora-Bajén, Víctor and Perez, Javier J., Emu Deepening and Sovereign Debt Spreads: Using Political Space to Achieve Policy Space (January 19, 2021). Banco de Espana Working Paper No. 2103 , Available at SSRN: https://ssrn.com/abstract=3769347 or http://dx.doi.org/10.2139/ssrn.3769347

Iván Kataryniuk (Contact Author)

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

Víctor Mora-Bajén

Banco de España

Alcala 50
Madrid 28014
Spain

Javier J. Perez

Banco de España - Research Department ( email )

Alcala 50
28014 Madrid
Spain

HOME PAGE: http://www.bde.es/investigador/staff/95.htm

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