علیت -گرنجر در بازارهای جانبی بدهی های عمومی اتحادیه پولی اروپا : یک رویکرد پویا

Our research aims to analyze the possible existence of Granger-causal relationships in the behavior of public debt issued by peripheral member countries of the European Economic and Monetary Union (EMU), with special emphasis on the recent episodes of crisis triggered in the eurozone sovereign debt markets since 2009. With this goal in mind, we make use of a database of daily frequency of yields on 10-year government bonds issued by five EMU countries (Greece, Ireland, Italy, Portugal and Spain), covering the entire history of the EMU from its inception on 1 January 1999 until 31 December 2010. In the first step, we explore the pair-wise Granger-causal relationship between yields, both for the whole sample and for changing subsamples of the data, in order to capture the possible time-varying causal relationship. This approach allows us to detect episodes of significant increase in Granger-causality between yields on bonds issued by different countries. In the second step, we study the determinants of these episodes, analyzing the role played by different factors, paying special attention to instruments that capture the total national debt (domestic and foreign) in each country.

After 10 years of stability, the financial and economic crisis that followed the US subprime crisis and Lehman Brothers collapse highlighted the imbalances within the European Economic and Monetary Union (EMU) countries. These imbalances had probably been undervalued during the stability period when markets seemed to underestimate the possibility that governments might default. Nevertheless, from August 2007 onwards, in parallel with the rise in global financial instability that led to a “flight-to-quality”, yield spreads of euro area issues with respect to Germany spiraled (see Fig. 1a and Fig. 1b). Moreover, since 2010, Greece has been bailed out twice and the Republic of Ireland and Portugal also needed bailouts to stay afloat. These events brought to light the fact that the origin of sovereign debt crises in Europe could even go beyond the imbalances in public finances.After 10 years of stability, the financial and economic crisis that followed the US subprime crisis and Lehman Brothers collapse highlighted the imbalances within the European Economic and Monetary Union (EMU) countries. These imbalances had probably been undervalued during the stability period when markets seemed to underestimate the possibility that governments might default. Nevertheless, from August 2007 onwards, in parallel with the rise in global financial instability that led to a “flight-to-quality”, yield spreads of euro area issues with respect to Germany spiraled (see Fig. 1a and Fig. 1b). Moreover, since 2010, Greece has been bailed out twice and the Republic of Ireland and Portugal also needed bailouts to stay afloat. These events brought to light the fact that the origin of sovereign debt crises in Europe could even go beyond the imbalances in public finances.Indeed, the main causes of the debt crises in Europe vary according to the country and reflect an important interconnection between public and private debt. In Ireland, the crisis was mainly due to the private sector, particularly a domestic housing boom which was financed by foreign borrowers who did not require a risk premium related to the probability of default (see Lane, 2011). In Spain, since absorption exceeded production, the external debt grew and the real exchange rate appreciated, implying a loss of competitiveness for the economy. Unlike previous expansions, the resort to financing was not led by the public sector but by private households and firms. In contrast to Ireland and Spain, the origin of the debt crisis in Greece and Portugal was the structural deficit in the government sector. If the crisis spreads to Italy, this structural deficit would be the possible cause. Greece and Italy’s large fiscal deficit and huge public debt are the cumulative result of chronic macroeconomic imbalances1. However, the case of Portugal illustrates the importance of external debt2 (specifically, that of its private sector: banks and enterprises). Some studies have already found a strong relationship between risk premium and a wide range of vulnerability indicators that go beyond the fiscal position. The IMF (2010) and Barrios et al. (2009) present empirical evidence of the strong relationship between current account deficits and foreign debt and the behavior of sovereign risk premium. Moreover, Gros (2011) contends that foreign debt is more important than public debt, and that this may have a number of implications for the ongoing eurozone crisis3. Other authors (Bolton and Jeanne (2011) and Allen et al. (2011), to name a few), have focused on the study of cross-border banking system linkages to the government sector. Although, cross-border banking effect on risk diversification is a key benefit, foreign capital is likely to be more mobile than domestic capital and, in a crisis situation, foreign banks may simply decide to “cut and run”. In addition, in an integrated banking system, financial or sovereign crisis in a country can quickly spill over to other countries. In this context, it is important to note that the European Union and, especially the euro area, witnessed a significant increase in cross-border financial activity over the 10 years before the global crisis (see Barnes et al., 2010). Both the elimination of currency risk and regulatory convergence4 can explain this important increase (see Kalemli-Ozcan et al., 2010). Spiegel, 2009a and Spiegel, 2009b shows that the effect of the monetary union has been even stronger for some of the peripheral EMU countries. In particular, the sources of external financing for Portuguese and Greek banks radically shifted on joining the euro; traditionally reliant on dollar debt, these banks were subsequently able to raise funds from their counterparts elsewhere in the EMU. Therefore, in this scenario of increased cross-border financial activity in the euro area, Gray et al. (2009) point out the importance of identifying the channels that connect the banking and the sovereign sectors, not only within a country but across countries as well. On the one hand, a systemic banking crisis can induce a contraction of the entire economy, weakening public finances and thus transferring the distress to the government. This effect is amplified when the financial sector has state guarantees. As a feedback effect, risk is further transmitted to holders of sovereign debt. On the other hand, macroeconomic imbalances in a specific country lead to rising sovereign spreads and a devaluation of the government debt that is mirrored in banks’ balance sheets. Moreover, as the recent European sovereign debt crisis has stressed, transmission of the crisis in one country to others through the banking system can be a major issue. The recent literature on sovereign debt has not studied these linkages in depth. Only a handful of recent papers have addressed the interaction between sovereign default and the stability of the domestic financial system. The analyses by Mody, 2009 and Ejsing and Lemke, 2009, Gennaioli et al. (2010) and Broner and Ventura (2011), are among them5. The papers most closely related to our analysis are the studies by Bolton and Jeanne (2011) and Andenmatten and Brill (2011). Bolton and Jeanne’s (2011) central issue is the analysis of the international contagion caused by the banks’ exposure to the sovereign risk of foreign countries. To that end, they use data from the 2010 European stress test and show that financial integration without fiscal integration results in an inefficient equilibrium supply of government debt.6Andenmatten and Brill (2011) perform a bivariate test for contagion that is based on an approach proposed by Forbes and Rigobon (2002) to examine whether the co-movement of sovereign CDS premium increased significantly after the beginning of the Greek debt crisis in October 2009. Unlike Forbes and Rigobon, they conclude that in European countries “both contagion and interdependence” occurred. However, an important constraint in the above-mentioned empirical evidence is the fact that it ignores the dynamic component of the degree of interconnection of public debt markets. In this regard, Abad et al., 2010 and Abad et al., forthcoming examine the European government bond market integration from a dynamic perspective, applying an asset pricing model to a dataset spanning the years 2004–2009.7 Nonetheless, the evolution of the time-varying degree of causality of EMU sovereign debt yields behavior (and the factors behind it, especially the role played by private debt and cross-border banking linkages) has not yet been analyzed in sufficient depth by the literature. This paper aims to carry out an analysis of this kind. Thus, the main objectives of this paper are threefold: (1) to test for the existence of possible Granger-causal relationships between the evolution of the yield of bonds issued by peripheral EMU countries, (2) to examine the time-varying nature of these Granger-causal relationships and to detect episodes of significant intensification in causality between them, and (3) to analyze the determinants of those events considering not only macroeconomic imbalances, but also the role played by market liquidity, private debt, cross-border banking linkages, indicators of investor sentiment and global risk aversion. This paper also makes three main contributions to the existing literature. First, it presents a dynamic approach to the analysis of the evolution of the degree of Granger-causality of EMU sovereign debt yields behavior. Second, it makes use of a unique dataset on private debt-to-GDP by sector (households, banks and non-financial corporations) in each EMU country and on cross-border banking linkages. Private debt dataset has been built up by the authors using the Monetary Financial Institutions (MFI) balance sheet statistics provided for each euro country by the European Central Bank, whilst cross border banking linkages are measured using the consolidated claims on an immediate borrower basis of Bank for International Settlements reporting banks (in the public, the banking and the non-financial private sectors). Third, it focuses the analysis on peripheral EMU countries (Greece, Ireland, Italy, Portugal and Spain) since these are the countries which have come under market pressure since 2009, reflecting investors’ perceptions of risks, and which to a large extent have been the origin of the current sovereign debt crisis in the whole eurozone. The most important results of the analysis can be summarized as follows. Firstly, we provide empirical evidence of the existence of sub-periods of Granger-causality in all pair-wise relationships. Secondly, we also present empirical evidence which indicates that the Granger-causality relationships between peripheral EMU yields have significantly increased during the recent crises in sovereign debt markets from 2009. Thirdly, the results of the Probit models estimated to analyze the determinants of the episodes of Granger-causality intensification show that in all cases the variable that captures cross-border banking linkages is statistically significant. This finding might suggest that, not only macroeconomic imbalances may be key determinants of the probability of occurrence of those episodes, but in a scenario of increased international financial activity in the euro area, transmission of the crisis in one country to other countries through the banking system can be a major issue. Lastly, the results support the important role played by private debt, especially in the cases of Ireland, Italy and Spain. The rest of the paper is organized as follows. Section 2 presents the Granger-causality analysis and our approach for the detection of episodes of increase in Granger-causality. In Section 3 we carry out the exploration of the determinants of these episodes. Finally, Section 4 summarizes the findings and offers some concluding remarks.

In the current context of uncertainty in European sovereign debt markets, the analysis presented in this paper deals with a subject that has not been addressed deeply enough by the literature and is of particular relevance both to academics and to policy-makers. In particular, this paper presents a dynamic approach to the analysis of the evolution of the degree of Granger-causality between peripheral EMU sovereign yields behavior (Greece, Ireland, Italy, Portugal and Spain). To this end, we have (1) tested for the existence of possible Granger-causal relationships between the evolution of these countries’ 10-year yields, (2) examined the time-varying nature of these Granger-causal relationships to detect episodes of significant increase of causality between them, and (3) analyzed the determinants of these episodes. Since it seems increasingly clear that the origin of sovereign debt crisis in Europe has gone beyond the imbalances in public finances and that there is an obvious interconnection between public and private debt, we have analyzed the role of the latter in the episodes of Granger-causality intensification by using a unique dataset on private debt-to-GDP by sector (households, banks and non-financial corporations) in each peripheral EMU country. Besides, since the reasons that may explain transmission of sovereign debt crisis from one country to another can be fundamental-based or investor behavior-based, we have included instruments that capture both types. In addition, we have borne in mind that fundamental-based interconnection works not only through real linkages, but also through financial linkages across countries. Specifically, in the current scenario of increased cross-border financial activity in the euro area, special attention has been paid to the impact of the degree of integration of the banking system on the speed at which a sovereign crisis in a country can spill over to others. This channel of transmission has generally been ignored by the recent literature, but its relevance is crucial. The main findings of our analysis can be summarized as follows. Firstly, the results of the rolling analysis we apply in order to explore the dynamic causality between peripheral EMU yields suggest that there exist sub-periods of Granger-causality in all pair-wise relationships. Secondly, our empirical evidence suggests that the episodes with significant Granger-causality increase are concentrated around the first year of the launch of the EMU in 1999, the introduction of euro coins and banknotes in 2002 and, specially, the global financial crisis in the late-2000s. Therefore, our results indicate that the Granger-causality relationships between peripheral EMU yields have been significantly reinforced during the recent crises in sovereign debt markets since 2009. Thirdly, the results of the Probit models estimated to analyze the determinants of the previously detected episodes indicate that in all cases the variable that captures cross-border banking linkages is statistically significant. This finding suggests that, in a scenario of increased international financial activity in the euro area, transmission of the crisis in one country to other countries through the banking system may be a central issue (this is explained by the “financial trilemma” laid out by Schoenmaker, 2011). It is worth noting that macroeconomic imbalances in a specific country (the instruments we have used to capture them also indicate that they are key determinants of the probability of occurrence of an episode of Granger-causality’s increase) lead to rising sovereign spreads and a devaluation of the government debt that is mirrored in banks’ balance sheets. Moreover, regarding the role of private debt, we find evidence of its high relevance in the cases of Ireland and Spain. In these two countries, in contrast to Greece and Portugal (were the origin of the debt crisis was the structural public deficit), the private sector’s indebtedness has been pointed out as the main cause of the debt crisis. Therefore, as mentioned, our results suggest that euro area crisis faces multiple overlapping and mutually reinforcing elements of fiscal (Greece and Portugal), banking (Ireland and Spain), and competitiveness (Southern periphery) crises. This situation has lead many authors (see, for example, Bergsten and Kirkegaard, 2012) to state that the euro area is foremost facing a crisis of “institutional design”. Indeed, the euro crisis began more than 3 years ago and there is still no end in sight. The main reason for this situation is that some of its root causes have been left largely unattended. In particular, no mechanism has been put in place to address the feedback loop between sovereigns and banks shown by our results. In this context, Pisani-Ferry (2012) lays out that the euro was imagined in the late 1980s in response to what was known as Mundell’s trilemma, according to which no country can enjoy at the same time free capital flows, stable exchange rates and independent monetary policies. According to this author, 20 years later, the euro area faces another trilemma that stems from three of the basic principles upon which the European currency is based: the absence of co-responsibility over public debt, the strict no-monetary financing rule and the national character of banking systems. The coexistence of these three principles makes the euro area fragile. Therefore now, as 20 years ago, the question is which of the constraints the euro area should give in. The problem is that putting in place the necessary mechanism to solve the trilemma would involve transforming the euro area into a full-fledged monetary union with a fiscal and banking union. Although nothing short of a political union might ultimately be sufficient to ensure the long term viability of the monetary union, it is equally clear that it will take significant time to achieve even under the most optimistic assumptions. At this juncture, however, what appears more feasible and some of the short run policy implications that we suggest in this paper to fight this crisis are the following. The euro area would need (a) to take a decisive step forward by creating a banking union (see, for example, Pisani-Ferry et al., 2012, or Schoenmaker and Gros, 2012) and/or (b) to issue jointly guaranteed Eurobonds (see Favero and Missale, 2011, Delpla and von Weizsäcker, 2010 and Delpla and von Weizsäcker, 2011, or Claessens et al., 2012, among others).