Posts Tagged ‘Crisis’

Loose Lips Sinking Markets?

The ECB in July 2013 published an extremely interesting paper on “The Impact of Political Communication on Sovereign Bond Spreads.” Here are some highlights.

Keep in mind that, “Euro area countries are more exposed to the risk of self-fulfilling crises whereby investors generate a liquidity crisis that can degenerate into a solvency crisis.”

Correcting for financial, economic and other political events, this study finds that political communication – both of a positive and negative nature – does have a daily contemporaneous effect on sovereign bond yield spreads.

Similarly, an interesting finding is that economic fundamentals appear not to have a significant influence on bond spreads in the short term, but are instead overwhelmed by statements, credit rating changes and country specific events.

Bond investors will price risk appropriately only if the realistically face a danger of default. Governments will run sound fiscal policies only if they know that they are not going to be bailed out by the euro area and that they might face higher financing costs. This debate about incentives and principles is a fully legitimate one in open democratic societies. However, it has sent a possibly destabilising message to potential investors in the bonds issued by troubled countries, namely that those bonds are not safe assets because the probability of a complete redemption was seen as reduced, and this with a perceived (semi-)official sanction. Investors have therefore demanded a large risk premium. This, in turn, may have contributed further to the fiscal problems in the peripheral euro area countries over the past two years. Policy-makers are therefore confronted with a certain trade-off between conducting open democratic debates and respecting the needs of the financial markets, reflected by the controversy over the notion of a “democracy in conformity with market needs.”

This study does not find any strong empirical evidence that the amount of political communication has an impact on the level of government bond yields. Rather, our finding is that the connotation of the communication determines the type of impact on government bond yields: positive communication can lead to a compression of spreads, whereas negative communication can cause a widening of pspreads.

Communication policy would be more effective if certain principles were respected in the design and implementation of politicians’ communication strategies.

At several points during the crisis, certain types of political communication may have added uncertainty rather than certainty to market perceptions about the sovereign debt crisis in the euro area, and that unconstructive and inconsistent communication can have real and tangible effects on countries, their financing conditions, and by extension, on their populations, as well as on the cohesion of the euro area.

I fear that one can safely argue that the impact of governmental change in Germany in 2009 and especially the entry of the FDP into power was not a good thing for the Eurozone.

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The View from 2008 – Exploiting Europe’s Strong Potential

I just read an interesting paper from 2008 about the Euro’s tenth birthday approaching but with the Euro debt crisis not yet omnipresent. Apart from a few – in retrospective – amusing nuggets:

“The attractions of the euro should be actively promoted in the non-participating member states. This task is becoming easier as it becomes ever more clearly a pole of stability in the global system.”
“Ten years [after the introduction of EMU] later we can rejoice in the success of the euro and can comfortably predict that it is here to stay.”

The paper is insightful and holds up quite well in part of its analysis. Two aspects especially struck me as interesting:

First, the authors point to an inherent trade-off between attempts to raise productivity: “The sequencing of policy implementation must be right. The unemployment rate in the eurozone, albeit diminishing, ist sill relatively high at around 7%. This needs to be fixed before any measure to boost productivity is undertaken. Indeed, the process of job creation reduces productivity, so there is no point in trying to achieve two conflicting targets at once.” In Spain, productivity has actually risen at exactly the cost laid out above though, an unemployment rate of 7% would be good news in most of Southern Europe in fact. Yet, productivity – considering continued low inflation in the core and accordingly the limited impact of nominal wage changes for  relative unit labor costs in the South – clearly is one of the most important channels through which a sustainable current/capital account rebalancing could occur (one that is not predominately based on the disappearance of domestic demand that is: see here). It is not clear how this circle could be squared then.


There is clear evidence pointing to the rising divergence in real exchange rates in EMU. At the root of this divergence are differences in the growth of national price levels. These are not only a function of cyclical positions but are also determined by the shape of national institutions, and of labour markets above all. Yet, labour markets do not operate in a vacuum. Their functioning is often conditioned by the fiscal and monetary policy regime under which they operate. In particular, the monetary policy regime change that came about with the inception of EMU has altered national unions’ incentive structures. As an example of this, coordinated labour markets in large countries are under a stronger incentive to restrain wage growth than their equivalents in small countries. This is because domestic inflation in large countries affects average eurozone inflation and therefore the ECB’s conduct of monetary policy. Germany for instance, has been pursuing a wage restraint policy in recent years, which has resulted into a significantly below-average wage growth and impressive real exchange rate depreciation.”
This is a really interesting argument as it – if one follows through with it – means that even the creation of German-style collective wage negotiations in the South would not remove incentives for small country unions to ask for higher wage increases than in bigger countries, simply because without them having an impact on the overall Eurozone inflation they raise, exemplary, Portuguese workers’ relative (and absolute) purchasing power. It is not just the make-up of different national wage-setting mechanisms that gives rise – or contributes – to macroeconomic imbalances within the Eurozone but the very existence of – still predominately – national economies.
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