Ekkehard Köhler (Walter Eucken Institut und Universität Freiburg) – Re-convergence of Interest Rate Spreads of the GIIPS: Empirical Evidence of Fiscal and Monetary Actions and Interventions

What influenced the re-convergence of interest rates of GIIPS countries? A popular explanation why investors stopped worrying about a self-fulfilling debt crisis capable of collapsing the EMU (De Grauwe and Ji, 2012) points at Mario Draghi’s pledge to “do whatever it takes” to defend the “integrity of the union” (see for example: Eichengreen, 2015, p. 415). In this paper we closely examine this hypothesis in an unprecedented way. We empirically analyze the impact of conventional and extraordinary monetary (e.g. LTRO CBPP) and fiscal (e.g. EFSF EFSM) policy measures on 2-, 5- and 10-year bond yield and 2- and 5-year CDS yield spreads. We find that yield re-convergence is mostly explained by instruments unknown to investors before uncertainty spread on markets. We conclude that uncertainty about bailouts is a major driver for interest rate spreads – at least in the GIIPS countries where fiscal fundamentals played only a minor role, when uncertainty about bailouts was low. The upshot is as follows: First, this paper encourages for further theoretical research, as asset pricing theory does not adequately explain EMU government bond-pricing situation. Second, we find first evidence for a superior yield spread driving factor, namely investors’ uncertainty about bailouts. This paper is the first to explore the process of re-convergence of GIIPS sovereign bond yields, which restarted in Q3 2012, that had been, so far, not yet been sufficiently explained.