IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Systemic Sovereign Risk: Macroeconomic Implications in the Euro Area

  • Saleem Bahaj

    ()

    (University of Cambridge, Faculty of Economics
    Centre for Macroeconomics (CFM))

Registered author(s):

    What are the macroefconomic implications of changes in soverign risk premia? In this paper, I use a novel identification strategy coupled with a new dataset for the Euro Area to answer this question. I show that exogenous innovations in soverign risk premia were an important driver of the economic dynamics of crisis-hit countries, explaining 30-50% of the forecast error of unemployment. I also shed light on the mechanisms through which this occurs. Fluctuations in soverign risk premia explain 20-40% of the varience of private borrowing costs. Increases in soverign risk result in substantial capital flight, external adjustment and import compression. In contrast, governments appear not to increase their primary balances in response to increases in soverign risk. Identifying these causal effects involves isolating a source of fluctuations in soverign borrowing costs exogenous to the economy in question. I address this problem by relying upon the transmission of country-specific events during the crisis in Europe to the soverign risk premia in the remainder of the union. I construct a new dataset of critical events in the foreign crisis-hit countries and I measure the impact of these events on yeilds in the economy of interest at an intraday frequency. An aggregation of foreign events serves as a proxy variable for structural innovations to the yeild to identify shocks in a proxy SVAR. I extend this methodology into a Bayesian setting to allow for flexible panel assumptions. A counterfactual analysis is used to remove the impact of foreign events from the bond yields in crisis-hit cuntries: I find that 40-60% of the trough-to-peak moves in bond yields in crisis-hit countries are explained by foreign events, thereby suggesting that the crisis was not purely a function of weak local economic conditions.

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

    File URL: http://www.centreformacroeconomics.ac.uk/Discussion-Papers/2014/CFMDP2014-06-Paper.pdf
    Download Restriction: no

    Paper provided by Centre for Macroeconomics (CFM) in its series Discussion Papers with number 1406.

    as
    in new window

    Length: 59 pages
    Date of creation: May 2014
    Date of revision:
    Handle: RePEc:cfm:wpaper:1406
    Contact details of provider: Web page: http://www.centreformacroeconomics.ac.uk/

    More information through EDIRC

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

    as in new window
    1. Reinhart, Carmen M. & Rogoff, Kenneth, 2009. "The Aftermath of Financial Crises," CEPR Discussion Papers 7209, C.E.P.R. Discussion Papers.
    2. Yeyati, Eduardo Levy & Panizza, Ugo, 2011. "The elusive costs of sovereign defaults," Journal of Development Economics, Elsevier, vol. 94(1), pages 95-105, January.
    3. Canova, Fabio & Ciccarelli, Matteo, 2013. "Panel vector autoregressive models: a survey," Working Paper Series 1507, European Central Bank.
    4. Russell Cooper, 2012. "Debt Fragility and Bailouts," NBER Working Papers 18377, National Bureau of Economic Research, Inc.
    5. Eric Leeper & Todd Walker & Susan Yang SHu-Chun, 2009. "Fiscal Foresight And Information Flows," Caepr Working Papers 2009-001, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
    6. De Grauwe, Paul & Ji, Yuemei, 2013. "Self-fulfilling crises in the Eurozone: An empirical test," Journal of International Money and Finance, Elsevier, vol. 34(C), pages 15-36.
    7. Andrew Ang & Francis A. Longstaff, 2011. "Systemic Sovereign Credit Risk: Lessons from the U.S. and Europe," NBER Working Papers 16982, National Bureau of Economic Research, Inc.
    8. Carmen M. Reinhart & Kenneth S. Rogoff, 2011. "From Financial Crash to Debt Crisis," American Economic Review, American Economic Association, vol. 101(5), pages 1676-1706, August.
    9. Raffaela Giordano & Marcello Pericoli & Pietro Tommasino, 2013. "Pure or wake-up-call contagion? Another look at the EMU sovereign debt crisis," Temi di discussione (Economic working papers) 904, Bank of Italy, Economic Research and International Relations Area.
    10. Andrew K. Rose, 2002. "One Reason Countries Pay Their Debts: Renegotiation and International Trade," Working Papers 042002, Hong Kong Institute for Monetary Research.
    11. Bertrand Candelon & Amadou N. R. Sy & Rabah Arezki, 2011. "Sovereign Rating News and Financial Markets Spillovers; Evidence From the European Debt Crisis," IMF Working Papers 11/68, International Monetary Fund.
    12. Faust, Jon & Swanson, Eric T. & Wright, Jonathan H., 2004. "Identifying VARS based on high frequency futures data," Journal of Monetary Economics, Elsevier, vol. 51(6), pages 1107-1131, September.
    13. Pontus Rendahl, 2014. "Fiscal Policy in an Unemployment Crisis," Discussion Papers 1405, Centre for Macroeconomics (CFM).
    14. Domenico Giannone & Michele Lenza & Giorgio E. Primiceri, 2012. "Prior Selection for Vector Autoregressions," NBER Working Papers 18467, National Bureau of Economic Research, Inc.
    15. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-61, September.
    16. Laurence M. Ball & Daniel Leigh & Prakash Loungani, 2013. "Okun's Law: Fit at Fifty?," NBER Working Papers 18668, National Bureau of Economic Research, Inc.
    17. James Mitchell & Richard J. Smith & Martin R. Weale & Stephen Wright & Eduardo L. Salazar, 2005. "An Indicator of Monthly GDP and an Early Estimate of Quarterly GDP Growth," Economic Journal, Royal Economic Society, vol. 115(501), pages F108-F129, 02.
    18. Shafik Hebous, 2011. "The Effects Of Discretionary Fiscal Policy On Macroeconomic Aggregates: A Reappraisal," Journal of Economic Surveys, Wiley Blackwell, vol. 25(4), pages 674-707, 09.
    19. Lawrence Christiano & Martin Eichenbaum & Sergio Rebelo, 2011. "When Is the Government Spending Multiplier Large?," Journal of Political Economy, University of Chicago Press, vol. 119(1), pages 78 - 121.
    20. Valerie A. Ramey, 2011. "Identifying Government Spending Shocks: It's all in the Timing," The Quarterly Journal of Economics, Oxford University Press, vol. 126(1), pages 1-50.
    21. Corsetti, Giancarlo & Dedola, Luca, 2013. "The Mystery of the Printing Press: Self-fulfilling debt crises and monetary sovereignty," CEPR Discussion Papers 9358, C.E.P.R. Discussion Papers.
    22. Michael Tomz & Mark L. J. Wright, 2007. "Do Countries Default In "Bad Times"?," CAMA Working Papers 2007-23, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    23. Valerie A. Ramey, 2011. "Can Government Purchases Stimulate the Economy?," Journal of Economic Literature, American Economic Association, vol. 49(3), pages 673-85, September.
    24. David J. Spiegelhalter & Nicola G. Best & Bradley P. Carlin & Angelika van der Linde, 2002. "Bayesian measures of model complexity and fit," Journal of the Royal Statistical Society Series B, Royal Statistical Society, vol. 64(4), pages 583-639.
    25. Eric R. Sims, 2012. "News, Non-Invertibility, and Structural VARs," Working Papers 013, University of Notre Dame, Department of Economics, revised Jun 2012.
    26. Christina D. Romer & David H. Romer, 2007. "The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks," NBER Working Papers 13264, National Bureau of Economic Research, Inc.
    27. Corsetti, Giancarlo & Guimaraes, Bernardo & Roubini, Nouriel, 2006. "International lending of last resort and moral hazard: A model of IMF's catalytic finance," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 441-471, April.
    28. Durbin, Erik & Ng, David, 2005. "The sovereign ceiling and emerging market corporate bond spreads," Journal of International Money and Finance, Elsevier, vol. 24(4), pages 631-649, June.
    29. John H. Cochrane & Monika Piazzesi, 2002. "The Fed and Interest Rates: A High-Frequency Identification," NBER Working Papers 8839, National Bureau of Economic Research, Inc.
    30. Enrique G. Mendoza & Vivian Z. Yue, 2012. "A General Equilibrium Model of Sovereign Default and Business Cycles," The Quarterly Journal of Economics, Oxford University Press, vol. 127(2), pages 889-946.
    31. Andrea Pescatori & Amadou N R Sy, 2007. "Are Debt Crises Adequately Defined?," IMF Staff Papers, Palgrave Macmillan, vol. 54(2), pages 306-337, June.
    32. Eduardo Borensztein & Ugo Panizza, 2008. "The Costs of Sovereign Default," IMF Working Papers 08/238, International Monetary Fund.
    33. Westermann, Frank & Steinkamp, Sven, 2013. "On Creditor Seniority and Sovereign Bond Prices in Europe," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79848, Verein für Socialpolitik / German Economic Association.
    34. Alan J. Auerbach & Yuriy Gorodnichenko, 2011. "Fiscal Multipliers in Recession and Expansion," NBER Working Papers 17447, National Bureau of Economic Research, Inc.
    35. António Afonso & Davide Furceri & Pedro Gomes, 2011. "Sovereign credit ratings and financial markets linkages: application to European data," Working Papers Department of Economics 2011/14, ISEG - School of Economics and Management, Department of Economics, University of Lisbon.
    36. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-fulfilling debt crises," Staff Report 211, Federal Reserve Bank of Minneapolis.
    37. Huixin Bi, 2010. "Sovereign Default Risk Premia, Fiscal Limits and Fiscal Policy," Caepr Working Papers 2010-007, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
    38. Cristina Arellano & Yan Bai, 2013. "Linkages across Sovereign Debt Markets," NBER Working Papers 19548, National Bureau of Economic Research, Inc.
    39. De Grauwe, Paul, 2011. "Governance of a Fragile Eurozone," CEPS Papers 5523, Centre for European Policy Studies.
    40. Craig Burnside & Martin Eichenbaum & Jonas Fisher, 2003. "Fiscal Shocks and Their Consequences," NBER Working Papers 9772, National Bureau of Economic Research, Inc.
    41. Christina D. Romer & David H. Romer, 2004. "A New Measure of Monetary Shocks: Derivation and Implications," American Economic Review, American Economic Association, vol. 94(4), pages 1055-1084, September.
    42. Robert B. Litterman, 1985. "Forecasting with Bayesian vector autoregressions five years of experience," Working Papers 274, Federal Reserve Bank of Minneapolis.
    43. Carlos Arteta & Galina Hale, 2006. "Sovereign debt crises and credit to the private sector," International Finance Discussion Papers 878, Board of Governors of the Federal Reserve System (U.S.).
    44. Carlo Favero & Francesco Giavazzi, 2012. "Measuring Tax Multipliers: The Narrative Method in Fiscal VARs," American Economic Journal: Economic Policy, American Economic Association, vol. 4(2), pages 69-94, May.
    45. Oliver de Groot & Fédéric Holm-Hadulla & Nadine Leiner-Killinger, 2013. "Cost of borrowing shocks and fiscal adjustment," Finance and Economics Discussion Series 2013-59, Board of Governors of the Federal Reserve System (U.S.).
    46. Aizenman, Joshua & Hutchison, Michael & Jinjarak, Yothin, 2013. "What is the risk of European sovereign debt defaults? Fiscal space, CDS spreads and market pricing of risk," Journal of International Money and Finance, Elsevier, vol. 34(C), pages 37-59.
    47. Keith Kuester & Gernot J. Mueller & Giancarlo Corsetti & André Meier, 2012. "Sovereign Risk, Fiscal Policy, and Macroeconomic Stability," IMF Working Papers 12/33, International Monetary Fund.
    48. Emi Nakamura & Jón Steinsson, 2013. "High Frequency Identification of Monetary Non-Neutrality," NBER Working Papers 19260, National Bureau of Economic Research, Inc.
    49. Furceri, Davide & Zdzienicka, Aleksandra, 2012. "How costly are debt crises?," Journal of International Money and Finance, Elsevier, vol. 31(4), pages 726-742.
    50. James Cloyne, 2013. "Discretionary Tax Changes and the Macroeconomy: New Narrative Evidence from the United Kingdom," American Economic Review, American Economic Association, vol. 103(4), pages 1507-28, June.
    51. Tirole, Jean, 2012. "Country Solidarity, Private Sector Involvement and the Contagion of Sovereign Crises," IDEI Working Papers 761, Institut d'Économie Industrielle (IDEI), Toulouse, revised Sep 2012.
    52. Yuriy Gorodnichenko & Michael Weber, 2013. "Are Sticky Prices Costly? Evidence From The Stock Market," NBER Working Papers 18860, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:cfm:wpaper:1406. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Martin Hannon)

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.