A European solution to wide Irish spreads

Influential Belgian economist Paul de Grauwe argues in a Vox piece that ECB should be buying Irish and other high-yield eurozone sovereign bonds in the secondary market to correct what he describes as “panic” pricing. I think he’s got a point and it would certainly help stabilize expectations about fiscal prospects here and in those other countries.

It’s certainly no more radical than actions currently being taken by the Fed to stabilize their markets. A promising idea?

9 replies on “A European solution to wide Irish spreads”

If the ECB is firmly of the view that the Euro-zone will not break up, then it would be irrational for them to buy German bonds over Irish bonds – i.e. Irish bonds offer a higher for “identical” risk!

I wouldnt be so confident the market has it wrong. By potentially taking on the liabilities of all the banks, the possibilitiy that the Irish government will have to default on its debt is real. Also, the governments attempt to rectify the situation has been simply pathetic; so far, its only taken amends to collect 10% of this years fiscal imbalance (which is well above the world average.) Most important, the fate of countries who have large fiscal imbalances and are stuck in demonstably unsuitable fixed exchange rate regimes has always been truly dismal.
Of course, one advantage of high interest rates is that they force the government to stabilise the finances sooner rather than later. Permitting the government to borrow more at low rates, would likely induce so much uncertainity that itd make matters even worse (a point made by Dermot McAleese and Sean Barrett many years ago.)

I wonder if we are seeing the downside of the contraction of hedge fund activity. Arbitraging irrational spreads was a big part of their game. There is an argument for the ECB to fill the void. Jeremy has a point about second guessing the market; but the omniscience of the market doesn’t seem quite seems so compelling in our post-bubble present.

And yet….when we read further “Only Greece and Ireland saw their bond rates increase significantly over the last year, suggesting that the increased spreads of these countries are not only due to panic”
therefore its not panic, at all or alone, in relation to ireland

I liked the article. Obviously this would be good for us! From a European perspective, I guess the key to getting this sort of plan accepted would be to show that these panics do not just hurt the PIIGS, but that the problems which the PIIGS are in consequence facing impose negative externalities on the rest of the Eurozone.

However, the key phrase in the article is “As the ECB will be forced very soon to engage in quantitative easing…”

I would love this to be true, but as of now the ECB is publicly ruling this out.

Its an interesting one. To some extent the market concerns — as reflected in our spreads etc — obviously reflect real factors,but is there also an element of irratonal fear?? The search for yield we have seen in the last few years has turned into a search for safety, even if that safety is bought at a considerable price.

Would such ECB purchases calm this by sending a signal to the market? Or might it only draw on more speculative activity against the peripheral members by trying to “draw a line” ? 1992 and the currency crisis come to mind.

It isn’t clear to what degree this represents ‘panic pricing’ in a credit-constrained, shoot-first-ask-questions-later world. Certainly, the implied default probabilities are still negligible, so some of the wilder claims swirling around the media are overblown.

Perhaps its merely the case that the State will just have to get used to the scrapping of 105% LTV, self-certified mortgages just like the rest of us!

On balance, I see recent developments in the peripheral bond spreads as a good thing. Look at how they’ve focused people’s minds. To me, this is the bond vigilantes imposing a bit of discipline on the public finances, and forcing the government to get serious in a way that they simply wouldn’t do if they could still borrow freely at a few bps over Bunds. It’s not as if the ability to borrow freely up to one’s eyeballs is an unalloyed good, as amply demonstrated everywhere we look these days.

Would I be right in seeing this piece as a ‘coat trail’ by ECB? I heard over the w/e that Merkel is in the process of changing finance ministers, so, will the ECB be brought in to the discussions for the G20??

Conspiracy stuff??

Like Kevin says the key to persuading the ECB that this would be a good idea is to demonstrate the negative externalities which would follow if any Eurozone member were to default. Of course it is highly unlikely that this “lunch” would be free – in all probability we would have to make more demonstrable progress in correcting the deficit in the public finances. So we would be getting an ECB-led stabilisation package through the back door! Mind you, just as scary as the graphs on bond spreads in the de Grauwe article was the last graph on unit labour costs

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