ECB Paper: Little Basis for Euro Zone ‘Solidarity’ When Sovereign Risks Rise
European Central Bank staffers conclude that market-based valuation of sovereign risk is a ?valid? way to discipline monetary plot ?especially but not only in era of crisis.?
The implication, a trio of economists write, is that there?s ?small justification for the claim that governments faced with high risk premiums during the crisis deserve the camaraderie of other governments in the euro area.? Two of the authors — Ludger Schuknecht and Guido Wolswijk– are from the ECB. The third, Juergen von Hagen, is from University of Bonn.
The timing of the paper, posted on the ECB?s Web site this week, is noteworthy amid debate over how European governments might craft an help package to Greece to help that country deal with its monetary crisis. A key message is that governments need to have even sounder monetary policies during expansions to avoid the costs of borrowing during crises. Greece has been criticized for not doing sufficient to reform its economy and finances last decade when its economy grew above the euro zone?s average.
The authors conclude that bond yield spreads over U.S. and German benchmarks ?can still largely be clarified on the basis of economic principles during the crisis.? In addition, financial markets ?penalize monetary imbalances much more strongly since the Lehman default in September 2008.?
While before Lehman Brothers an additional percent of deficit over Germany?s resulted in a 3.5 basis point widening in yield spread, after Lehman the spread effect ballooned to 12.6 basis points, the authors estimate.
?The crisis thus seems to have caused a significant change in the markets? assessment of the governments? monetary performance and the cost of wicked monetary behavior has augmented considerably,? they wrote.
?For Greece, Ireland and Portugal?relatively weak monetary performance clarifies nearly or more than half of the increase in the spreads during the crisis,? the economists write.