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Yields on sovereign debt, fragmentation and monetary policy transmission in the euro area: A GVAR approach

Listed author(s):
  • Victor Echevarria-Icaza

    (Instituto Complutense de Estudios Internacionales (ICEI). Universidad Complutense de Madrid.)

  • Simón Sosvilla-Rivero

    ()

    (Instituto Complutense de Estudios Internacionales (ICEI). Universidad Complutense de Madrid.)

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.

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File URL: http://eprints.ucm.es/41608/1/WP%2003-17.pdf
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Paper provided by Universidad Complutense de Madrid, Instituto Complutense de Estudios Internacionales in its series Working Papers del Instituto Complutense de Estudios Internacionales with number 1703.

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Length: 38 pages
Date of creation: 2017
Handle: RePEc:ucm:wpaper:1703
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