DNB W o r k i n g P a p e r. Public Debt Managers Behaviour: Interactions with Macro Policies. No. 273 / December 2010

Transcription

1 DNB Working Paper No. 273 / December 2010 Lex Hoogduin, Bahar Özürk and Peer Wiers DNB W o r k i n g P a p e r Public Deb Managers Behaviour: Ineracions wih Macro Policies

2 Public Deb Managers Behaviour: Ineracions wih Macro Policies Lex Hoogduin, Bahar Özürk and Peer Wiers * * Views expressed are hose of he auhors and do no necessarily reflec official posiions of De Nederlandsche Bank. Working Paper No. 273 December 2010 De Nederlandsche Bank NV P.O. Box AB AMSTERDAM The Neherlands

3 Public Deb Managers Behaviour: Ineracions wih Macro Policies December 2010 Paper prepared for he Banque de France conference on New Challenges for Public Deb in Advanced Counries, Srasbourg, Sepember 2010 Lex Hoogduin *, Bahar Özürk, Peer Wiers ** Absrac We invesigae he evoluion of public deb managemen, he policy behaviour of deb managers, and he impac of deb managemen on financial sabiliy and moneary policy. The focus is on he euro area. Empirical esimaions of a deb managemen reacion funcion indicae ha he share of shor erm deb (i) responds o he yield curve or he level of ineres raes, in line wih he objecive of cos minimisaion; and (ii) has been increasing especially since he onse of he economic crisis. The increase in shor erm deb brings abou higher refinancing risks and srenghens he ineracion of public deb managemen wih financial sabiliy and moneary policy. The sharp increase in cross border ownership of public deb since he adopion of he euro furher amplifies poenial spill-over effecs. Policy recommendaions focus on he need for ransparency on he use of derivaives and pruden deb managemen ha reflecs broader macroeconomic consideraions. * Execuive Direcor a De Nederlandsche Bank and Professor of Moneary Economics and Financial Insiuions a he Universiy of Amserdam, l.h.hoogduin@dnb.nl Economics and Research Deparmen, De Nederlandsche Bank, b.ozurk@dnb.nl Economics and Research Deparmen, De Nederlandsche Bank, peer.wiers@dnb.nl The auhors would like o hank, wihou implicaing hem, Paul Baneke, Aerd Houben, Geer Langenus, Frederik Mannears, Niek Nahuis, Tom van Veen, paricipans a he Banque de France conference on New Challenges for Public Deb in Advanced Counries, and paricipans a a workshop a he Duch Minisry of Finance for heir useful commens and suggesions. ** The opinions expressed in his aricle are hose of he auhors and do no necessarily reflec he views of De Nederlandsche Bank.

4 1. Inroducion Since he onse of he global financial crisis, fiscal posiions in mos of he euro area counries deerioraed significanly. Accordingly, public deb managers have been confroned wih srong increases in governmen borrowing needs. These and subsequen increases in sovereign risks have accenuaed he imporance of pruden public deb managemen. The way a counry s public deb is managed migh have imporan implicaions for he macroeconomic framework. 1 This is, of course, no o say ha by managing public deb in a pruden manner macroeconomic sabiliy will necessarily be guaraneed. In fac, sound public deb managemen is no enough by iself and can no solve macroeconomic imbalances nor address srucural financial secor problems. However, sound deb managemen can help reduce he risk ha he governmen s own porfolio will become a source of insabiliy boh wihin and across borders. Besides, i will make counries less suscepible o conagion and financial risks (IMF and he World Bank, 2003). Faced wih unprecedened borrowing needs, a number of deb managers in he euro area have changed heir borrowing sraegies by shifing he composiion of borrowing owards shor erm deb, inroducing or increasing deb issuance in foreign currency and/or increasing he use of financial derivaives. While financing deb beyond pruden amouns in he shor end of he marke could offer cos advanages in he shor erm, i migh also sow he seeds for larger coss in he longer erm. Besides, almos all public deb managers focus on minimizing he coss of heir naional porfolios, independen of one anoher. Developmens in Greece have shown ha hreas o one Member Sae s fiscal susainabiliy (and evenually financial sabiliy) can enail serious conagion risks for a number of oher Member Saes, and cas a shadow on he financial sabiliy of he whole currency union. The poenial for ineracion beween public deb managemen and moneary policy has increased due o he increase in shor erm deb, bu also as cenral banks have purchased governmen bonds in he secondary marke as a par of unconvenional moneary policies. 2 I is herefore highly relevan o improve our undersanding of public deb managers behaviour and is broader macroeconomic consequences. This paper addresses he following quesions: How can deb managemen behaviour in paricular he drive owards shor erm deb be 1 In his paper, he macroeconomic framework is defined as o encompass moneary policy, fiscal policy and also financial sabiliy. 2 While boh channels are highly relevan, his paper focuses more on he effec of shor erm deb. The effec of bond purchases on ineres raes is discussed, for example, in Joyce e al. (2010). 1

5 explained? Wha are he main macroeconomic spillovers associaed wih public deb managemen and how can hey be inernalized? 1 The remainder of his paper is srucured as follows. Secion 2 discusses he evoluion of public deb managemen and is objecives. Secion 3 invesigaes deb managemen pracices (i.e. financing decisions) based on esimaions of reacion funcions for euro area deb managers, focusing on he share of shor erm deb in oal issuance. Secion 4 analyzes he poenial implicaions of public deb managemen for financial sabiliy and moneary policy. Secion 5 summarizes he argumens and makes a number of policy suggesions. 2. Evoluion of public deb managemen and is objecives Unil abou wo decades ago, public deb managemen was seen as an exension of moneary and/or fiscal policy (Togo, 2007). I was no considered a separae macroeconomic policy and was given he ask of supporing he macroeconomic framework. During hese years, he ask of managing governmen deb was ofen in he hands of eiher fiscal or moneary auhoriies. Since he lae 1980s and hroughou he whole 1990s, however, he insiuional seing for public deb managemen has undergone a srong ransformaion for a number of OECD counries. Alhough he pace and he iming of he ransformaion varied per counry, is general direcion showed large similariies across counries (Currie e al, 2003). The ransformaion ino modern public deb managemen parly resuled from he macroeconomic policies of he 1960s and 1970s. Expansionary fiscal policies in he run up o he 1980s in many OECD counries led o increased deficis and public deb. Evenually, his fuelled concerns abou inflaion and fiscal susainabiliy (Currie e al, 2003). 3 In hose days, deb moneizaion was sill seen as a feasible opion available for he governmen o finance is deb. The pressure on moneary auhoriies would hus be even greaer if hey were also responsible for managing he public deb. Especially his laer concern riggered an influenial discussion on he objecives of differen macroeconomic policies and radeoffs inheren among hem. In he shor run, he objecives of moneary policy, fiscal policy and public deb managemen involve radeoffs (Cassard and Folkers-Landau, 1997). The argumen goes ha if he moneary auhoriy is responsible for boh moneary policy and public deb managemen, i migh be hesian o raise ineres raes o conrol inflaionary pressures or be emped o lower ineres raes in order o consrain deb servicing coss. This 3 For a deailed analysis of he evoluion of public deb managemen and is insuional implicaions, please refer o Currie, Dehier and Togo (2003). 2

6 would obviously go a he expense of he price sabiliy objecive. Gradually, he acknowledgmen of conflics of ineres and increased undersanding ha differen policy objecives are bes achieved by independen auhoriies paved he way for independen cenral banks, and public deb managemen offices were given a considerable degree of auonomy. Parallel o his change in he way of hinking and insiuional seing, developmens in he financial markes hroughou he 1980s and 1990s simulaed he emergence of modern public deb managemen. Financial marke liberalizaion and deregulaion increased he number of markes available o sovereign borrowers, assised financial innovaion and hus bolsered he developmen of new financial producs. Increased emphasis on cos and risk analysis encouraged public deb managemen o mimic porfolio managemen and gradually urn ino a more complex and sophisicaed aciviy. Alhough heir exac organizaion differs across euro area counries, deb managemen offices now have greaer auonomy wihin or ouside he Minisries of Finance (Wolswijk and de Haan, 2005). Along wih he insiuional and operaional ransformaion, he objecives of public deb managemen have undergone a remarkable shif from supporing macroeconomic policies o minimizing deb servicing coss. Tradiionally, heories of sovereign deb managemen aached i broad macroeconomic objecives such as ax smoohing (Barro, 1999), macroeconomic sabilizaion (Tobin, 1963) and defici sabilizaion (Missale, 2000). Currenly, a grea number of public deb managers adop objecives ha are akin o he one defined by he Guidelines for Public Deb Managemen (IMF and he World Bank, 2003): o ensure ha he governmen s financing needs and is paymen obligaions are me a he lowes possible cos over he medium o long run, consisen wih a pruden degree of risk. Apar from coss and risks, his objecive also refers o he planning horizon of deb managemen. However, no all deb managers refer o his planning horizon explicily and insead, define he objecive as o minimize deb servicing coss a accepable risk levels. This seemingly minor difference can lead o considerable differences in he pracices of deb managers. Minimizing coss a any poin in ime is differen from minimizing coss over a longer ime horizon. Wha migh seem cos-efficien oday may prove raher cosly over a number of years. I is exacly he acknowledgmen of his disincion ha migh help miigae he alleged dilemma of minimizing coss while conaining risks. As Piga (2001) saes, expeced cos minimizaion requires issuing shor erm deb. However, reducing he mauriy 3

7 of deb implies higher ineres rae- and refinancing risks. If hese risks maerialize, governmens will be forced o bear considerable increases in deb servicing coss. In some counries, he saed objecives of public deb managemen are exended o include he coordinaion of deb managemen aciviies wih fiscal and moneary policies. I is also emphasized in he Guidelines for Public Deb Managemen ha hese policies should be coordinaed. I remains unclear, however, under which circumsances macroeconomic consideraions would ouweigh cos consideraions. I is fair o argue ha a number of facors specific o he governmen disinguish i from a privae porfolio manager. Firs of all, since he governmen has much wider objecives han simply o minimize deb servicing coss, i can no ac as a privae agen in he marke. Second, compared o a porfolio manager, he amoun of risk ha a governmen can olerae migh be limied. According o Wheeler (1997), a governmen should follow he risk preferences of he median voer, who ends o be risk averse. Third, as will be discussed in Secion 4, he way he public deb is financed migh have imporan implicaions for he macroeconomic framework. 3 Explaining public deb managemen behaviour 3.1. Towards a deb managemen reacion funcion Several auhors have already invesigaed how deb managemen responded o he unprecedened increases in borrowing requiremens (e.g. Blommesein and Gok, 2009). One remarkable change has been he increase in he issuance of shor erm deb wih an original mauriy of up o one year. We aim o ake he analysis furher by sudying he drivers of governmen deb managers behaviour. Describing policy behaviour in erms of reacion funcions is common o fiscal and moneary policy. 4 For deb managemen, we are no aware of such esimaions; hence we make a firs aemp owards a deb managemen reacion funcion. Wih our dependen variable, i.e. shor erm financing relaive o oal financing, we aim o capure he core policy decision of deb managers, namely deciding on he mauriy. For a given level of financing needs, deciding on he mauriy is a crucial (perhaps he crucial) decision for he deb manager o make. 5 Furher, as menioned already, he share of shor erm deb is relevan for he exen of ineracions beween deb managemen and cenral bank policies relaed o financial sabiliy and moneary policy (see also Secion 4). 4 The lieraure is exensive. I is generally believed ha he sudy by Bohn (1998) marks he beginning of he lieraure on fiscal reacion funcions while he Taylor rule was firs proposed in Oher imporan policy decisions concern fixed versus floaing ineres raes, he currency denominaion and issuance of nominal versus index linked bonds. 4

8 A prior capuring deb managemen behaviour in an economeric model does no seem an easy ask. Deb offices issue a wide array of insrumens, for example index linked or nominal bonds, wih fixed or floaing raes, and/or denominaed in naional or foreign currency. Issuance decisions may reflec several demand and supply facors, which may poenially be difficul o disenangle. As a firs approach, and given daa limiaions, we herefore simplify our approach as much as possible. More advanced specificaions are lef for fuure research. An imporan cavea is ha our esimaions only capure issuance policy, which is highly observable o he marke. The esimaions do no capure how differen counries subsequenly influence he mauriy profiles of heir deb hrough he use of swaps, on which daa availabiliy is raher limied (see Box 1 for he use of financial derivaives in public deb managemen and he need for ransparency). Figure 1. Shor erm financing as a percenage of oal deb issuance Shor erm ousanding amouns as a percenage of oal issues Ausria Belgium Germany Spain Finland France Greece Ireland Ialy Neherlands Porugal Source: ECB SDW. Daa on our dependen variable i.e. he share of shor erm deb in eleven euro area counries as displayed in Figure 1 - indicae a more diverse paern across counries in comparison wih he increase in he level of shor erm deb. 6 A firs group of counries sars from a raher low share of shor erm deb a he beginning of our sample period, and subsequenly increases i hroughou his period (i.e. Germany, Finland, France, and The 6 According o our daa, shor erm ousanding amouns in he euro area more han doubled beween 2006 and 2009, from EUR 322 billion o EUR 725 billion. 5

9 Neherlands). 7 One of he purposes of our empirical analysis is hus o explain he move owards shor erm deb in hese counries. A second group of counries displays almos he opposie developmen. Having relaively high shares of shor erm deb a he sar of our sample period, some counries in his group reduced heir use of shor erm financing unil he urn of he cenury (i.e. Belgium, Porugal), and some ohers oped for a rend decline in he share of shor erm deb hroughou he sample period (i.e. Spain, Greece and Ialy). These counries migh have used he opporuniy brough by a more sable macro-economic environmen in he run-up o EMU o increase heir calls in he capial marke and hereby decrease heir dependence on shor erm deb. Box 1. The use of financial derivaives in public deb managemen Financial derivaives such as ineres rae and currency swaps have been widely used in governmen deb managemen since he 1980s. The ineres rae swap was developed in 1981 and grew fas since hen. In erms of noional principal amoun, he size of he marke had exceeded $500 billion already in 1987 (Fabozz 2010). Sovereign borrowers use ineres rae swaps for wo basic purposes. The firs purpose is o hedge a given ineres rae risk. A governmen paying a shor erm ineres rae can agree o pay a long erm rae in reurn for a shor erm rae. This allows deb managers o fine une he mauriy of deb and approach he benchmark porfolio, while preserving he predicabiliy of issuance in he capial marke. This is especially aracive when borrowing requiremens rise significanly and unexpecedly, as hey obviously did during Such a sraegy migh also be cheaper han issuing deb direcly in he capial marke, depending on he difference beween he yield on deb and he swap rae. A second reason could be o increase risk-aking and reduce financing coss. Euro area deb managers are widely pursuing his sraegy by enering ino swap conracs o pay shor erm ineres raes in reurn for long erm raes. Some deb managers srive o enhance he liquidiy of long erm benchmark bonds in order o lower he liquidiy premium. This allows deb managers o issue long erm bonds and hus mainain liquidiy while reducing he duraion of porfolio by he use of ineres rae swaps. By agreeing o pay shor erm raes, deb managers ake on ineres rae risks wih he expecaion of lowering deb servicing coss. Alernaively, he deb manager can issue shor erm deb direcly in he money marke and refrain from swapping. However, by choosing for he alernaive sraegy he or she would be limiing he amoun of long-erm deb ha can be issued, and resric he liquidiy in he secondary marke for long erm bonds. Thus, ineres rae swaps help solve his dilemma by leing deb managers o separae he funding decision from he porfolio decision (Piga, 2001). 7 In addiion, Ausria shows a somewha mixed paern while Ireland has resored o shor erm deb only in recen years. 6

10 Financial derivaives are, however, no risk-free as hey inroduce counerpary risks. For example, whereas a Treasury bill also offers he advanage of low shor erm ineres raes, swaps bring he risk ha he oher pary o he conrac migh defaul on is obligaions. Wih a defaul of he counerpary, he governmen migh be forced o renew is deb probably a higher raes. Especially under curren circumsances, counerpary risk is a facor one needs o consider seriously when enering ino a swap conrac. As Piga (2001) argues, counerpary risk is likely o be higher during recessions. One way o miigae his risk would be o ener ino swap conracs only wih counerparies holding invesmen grade raings. However, during a financial urmoil, even his migh prove insufficien. For example unil is fall on 15 Sepember 2009, Lehman brohers held a raing of a leas an A from all hree major raing agencies, qualifying i as a crediworhy counerpary. 8 Credi raings do no always reveal he rue financial sae of a company or an insiuion and end o lag behind credi evens. Anoher way of miigaing he counerpary risk is o demand collaeral when enering ino a swap conrac. Sill, his does no provide a hedge agains he ineres rae risk in case a counerpary defauls. During financial urmoil, he marke value of he collaeral migh also shrink. Furher, liquidaion is usually a cosly and ime-consuming process. Governmen involvemen can lead o repuaion risk, which could hen lead o a broader loss of confidence. Ineres rae swaps cover only one ype of risk. Swapping shor erm ineres raes for long erm raes adjuss ineres rae risk bu no refinancing risk. Furher, when used beyond he measure of prudence, swaps migh hamper he ransparency of deb managemen significanly. Mos ofen, sovereign borrowers use only plain vanilla swaps. However, here are cases where more sophisicaed ineres rae swaps are used. The lack of available informaion on he deails of swap arrangemens makes i difficul for invesors or ineresed insiuions o judge financing decisions of deb managers. Overall, we conclude ha swaps are useful ools as long as hey are no employed excessively and no used for creaive compliance wih benchmarks Hypoheses on he behaviour of public deb managers This secion discusses he facors ha can poenially affec deb managers behaviour, as capured by our dependen variable (i.e. share of shor erm financing as of oal). On he basis of he objecives of naional deb managers, we expec yearly financing flows o be driven mainly by cos and risk consideraions. Cos consideraions are refleced by he response o ineres raes. Deb managers may reac o he level of ineres raes and/or o he difference beween long and shor erm ineres raes (i.e. he yield curve). For example, a higher long erm ineres rae implies more expensive capial marke financing and may increase he share 8 Before is fall, Lehman Brohers raing from S&P was A, from Moody s A2 and from Fich A+. 7

11 of shor erm financing (posiive effec). Similarly, a higher shor erm ineres rae implies more expensive money marke financing and may decrease he share of shor erm financing (negaive effec). If boh effecs are equally srong, deb managers only reac o he difference beween he long and shor erm ineres raes, ha is o he yield curve, and do no respond o absolue levels per se. If his is he case, he coefficien of he yield curve should be posiive, while he coefficien for he absolue level of he ineres rae should be insignificanly differen from zero. Risk consideraions are usually refleced by a benchmark for he mauriy srucure of governmen deb. We herefore expec he consan in our regression o be saisically significan, and beween 0 and 100 per cen. In he hypoheical case where deb managers always finance a fixed amoun of heir financing needs in he money marke, his would be he only variable ha is saisically significan. 9 Variables capuring marke circumsances may also play a role. The exen of ease wih which he deb manager can ap a marke increases wih he liquidiy of ha marke. Moreover, during periods of increased volailiy in he marke, i migh be more difficul o issue long erm bonds. Likewise, in an inflaionary environmen, invesors migh op for shor erm posiions, leading o a posiive effec. Given ha expeced inflaion is already included in nominal ineres raes, we also run a separae regression wih real ineres raes and inflaion. The impac of fiscal policy on our dependen variable is refleced by he coefficien of ne financing needs (i.e. excluding redempions). High financing needs migh be difficul o mee in he capial marke, where he predicabiliy of deb issuance is considered vial. In his case, he coefficien of ne financing needs would be posiive. Besides increasing financing needs, he ousanding sock of deb migh also influence deb managemen behaviour. On he one hand, higher ousanding amouns could imply ha a lower fracion should be financed in he money marke in order o limi exposure o ineres rae shocks. Alernaively, higher deb may also signal higher credi risk and limi access o he capial marke. Thus, he expeced sign is ambiguous. Moreover, he effecs of special evens ha possibly influence financing decisions are capured by dummies. An EMU dummy ( ) corresponds o he insiuional change brough abou by he euro. Given ha i also roughly coincides wih an increase in focus on coss by naional deb managers, we expec a posiive coefficien, if anyhing. Nex o a crisis dummy ( ), for which we expec a posiive coefficien, we 9 Noe ha a regression on a consan only gives he mean of he dependen variable. 8

12 also include a dummy for he conversion o he euro. A he ime of conversion, deb managers were buying back bonds in heir own currency and issuing bonds in euros in reurn. The coefficien for he conversion dummy is herefore expeced o be negaive. 10 Finally, we expec a saisically significan coefficien for he lagged dependen variable since a high ousanding shor erm deb by he end of a year implies ha a large fracion of i will have o be refinanced in he following year Resuls In explaining he behaviour of deb managers, we employ a general o specific approach, where we subsequenly drop variables ha are no saisically significan. As a firs approach, we employ yearly daa in order o mainain he link wih he annual budgeary cycle. We resric our approach o he euro area and he period due o daa availabiliy. Our panel includes he larger euro area counries: Ausria, Belgium, Germany, Spain, Finland, France, Greece, Ireland, Ialy, The Neherlands and Porugal. More informaion on daa sources and definiions can be found in Annex 1, while Annex 2 conains deails on he esimaed equaion, he esimaion echnique and robusness checks. We firs look a he impac of he level of ineres raes and he yield curve. These variables are insrumened wih heir own lags o correc for possible reverse causaliy. We include in our esimaions he yield curve and he long erm ineres rae, which have a much lower correlaion han he one beween long erm and shor erm ineres raes. Alernaively, his specificaion can be rewrien ino he separae effec of long erm and shor erm ineres raes: Yield * LR * LR SR * LR * LR * SR *. (1) Where LR is he long erm ineres rae and SR is he shor erm ineres rae. In oher words, given ha we conrol for he effec of he long erm ineres rae, he coefficien for he yield curve can also be inerpreed as he response o he shor erm ineres rae (bu wih a negaive sign). Table 1 repors he resuls ha remain afer saisically insignifican variables were dropped. Resuls in column (1) for all eleven counries in he sample are based on he resricive assumpion ha deb managemen during he sample period behaved in a similar manner in all 10 Many hanks o Niek Nahuis for his suggesion o include his effec. 9

13 counries. Resuls show a saisically significan posiive response o he long erm ineres rae, a high degree of persisence (lagged dependen variable of 0.70), and expeced signs for he dummy variables. Columns (2) and (3) loosen he resricion of a common behaviour in he whole euro area and show resuls for wo differen groups of counries. The division ino wo groups is moivaed by differences in financing paerns as discussed already in Secion 3.1, and robusness checks on he inclusion and exclusion of counries in each group. Table 1. Esimaions of deb managemen behaviour All counries DE, FI, FR, NL, IR, AT ES, EL, IT, PT, BE (1) (2) (3) Yield curve 3.01 (3.89)*** Nominal long erm ineres rae (0.26)*** (0.30)*** D(Sock marke volailiy) 0.28 (0.15)* Toal ousanding amouns / GDP, lagged (0.12)*** Lagged dependen variable (0.036)*** (0.12)*** (0.058)*** Consan (1.68) (3.89)*** (1.95)*** EMU dummy (0.74)*** (1.90)*** Crisis dummy (0.73)*** (1.69)*** Euro dummy (2.90)** (0.54)*** Esimaion mehod 2S-EGLS a 2S-EGLS a 2S-EGLS a Fixed effecs Yes Yes Yes GLS weighs Cross-secion Cross-secion Cross-secion Adjused R Sample period N Noes: a The esimaion mehod is wo-sage esimaed generalized leas squares wih cross-secion weighs. Heeroskedasiciy and serial correlaion consisen sandard errors are in brackes below he poin esimaes, * = significance a he 10% level, ** = significance a he 5% level, *** = significance a he 1% level. The insrumens for he nominal long and shor erm ineres raes and he yield curve are he lagged long raes and shor raes unil he second lag. Furher, N = number of observaions. D sands for he firs difference. Resuls now show ha more variables are saisically significan. Column 2 (i.e. for DE, FI, FR, NL, IR and AT) indicaes ha cos consideraions show up in he response o he yield curve, wih a seeper yield curve implying higher shor erm financing. Moreover, he share of shor erm financing decreases wih increasing ousanding sock of deb. Hence, higher deb seems o lead o a more pruden financing. An increase in marke volailiy implies more 10

14 shor erm financing in his group, possibly as a resul of demand effecs. A remarkable resul is ha he period since 1999 coincides wih a level shif in he share of shor erm financing of 10% poins (i.e. coefficien of EMU dummy). One possible explanaion is he increasing focus on coss since he urn of he cenury. Moreover, he crisis period coincides wih anoher highly significan increase in shor erm financing by 8% poins (i.e. coefficien of crisis dummy). A frequenly menioned explanaion is ha capial marke financing was no available when large spikes in financing needs occurred during periods of high uncerainy. Finally, he size of persisence (of 0.39) is much lower han in column (1) now ha more variables appear saisically significan. Resuls in column 3 (i.e. for ES, EL, IT, PT and BE) sugges ha in his group, he share of shor erm financing responds o he level of long erm ineres raes and no o he yield curve. In oher words, decreases in long erm ineres raes which were in par relaed o decreases in inflaion raes over he sample period - may have led o longer erm financing for his group. The EMU and crisis dummies are no saisically significan in his specificaion, while ne financing needs urned ou o be saisically insignifican for all hree specificaions. We believe ha in acual pracice, deb managers focus more on marke ineres raes (i.e. nominal ineres raes) insead of real raes. Neverheless, by separaing he nominal ineres rae ino a real ineres rae and inflaion componen, we enrich he amoun of explanaory variables so ha we can gain addiional insighs. In column (1) of Table 2, he effec of inflaion becomes highly saisically significan wih he expeced sign as higher inflaion increases he share of shor erm financing. On he oher hand, he real yield curve and he level of real long erm ineres rae urned ou o be saisically insignifican 11. Resuls in column (2) indicae ha for counries wih a relaively sable inflaion, he share of shor erm financing is parly deermined by he yield curve. This coincides wih he effec o he shor erm ineres raes (of opposie sign) according o equaion (1). Column (3) indicaes ha for his group of counries (i.e. ES, EL, IT, PT, BE) inflaion developmens may have been a driving facor, given ha he real long erm ineres rae is no saisically significan while inflaion is highly significan wih he expeced posiive sign. In comparison wih able (1), our marke volailiy variable is now highly significan and shifs he deb manager owards less shor erm financing. Also he EMU and he crisis dummy are in his model highly 11 Because he level of real long erm ineres rae was insignifican in all hree specificaions, we did no include his variable in Table 2. 11

15 significan. In his group of counries, EMU coincided wih a decrease in he share of shor erm financing, which conrass wih he increase in he oher group. Table 2. Esimaions of deb managemen behaviour, including inflaion All counries DE, FI, FR, NL, IR, AT ES, EL, IT, PT, BE (1) (2) (3) Real yield curve 3.22 (0.92)*** Inflaion (0.38)*** (0.43)*** D(Sock marke volailiy) (0.17)* (0.11)*** Toal ousanding amouns / GDP, lagged (0.13)*** Toal ne issues / GDP (0.17)** Lagged dependen variable (0.030)*** (0.11)*** (0.054)*** Consan (1.32)*** (4.01)*** (3.71)*** EMU dummy (1.94)*** (2.26)** Crisis dummy (0.64)*** (1.79)*** (2.29)*** Euro dummy (0.93)*** (2.89)** (1.09)** Esimaion mehod 2S-EGLS a 2S-EGLS a 2S-EGLS a Fixed effecs Yes Yes Yes GLS weighs Cross-secion Cross-secion Cross-secion Adjused R Sample period N Noes: a The esimaion mehod is wo-sage esimaed generalized leas squares wih cross-secion weighs. Heeroskedasiciy and serial correlaion consisen sandard errors are in brackes below he poin esimaes, * = significance a he 10% level, ** = significance a he 5% level, *** = significance a he 1% level. The insrumens for he real yield curve and he real long and shor erm ineres raes are he lagged real long raes and shor raes unil he second lag. Furher, N = number of observaions. D sands for he firs difference. Overall, we conclude ha we can explain he financing behaviour of deb managers relaively well wih a few key variables: he yield curve, inflaion, marke volailiy, ousanding amouns, persisence, and EMU, euro conversion and crisis dummies. To our knowledge, we are he firs o describe he behaviour of deb managers in his manner. When comparing financing behaviour in he wo groups of counries, i appears ha he counries wih higher crediworhiness (i.e. column 2) are more acive in exploiing opporuniies creaed by a seep yield curve. A possible explanaion is ha higher crediworhiness allows hem o do so wihou causing adverse marke reacions, while issuance behaviour in he oher group of 12

16 counries is necessarily more cauious. As menioned earlier, an imporan cavea is ha while he issuance policy is highly visible o he marke, his is no he case for he subsequen effec of derivaives on risk profiles. Increased ransparency would allow furher research on he effecs of risk managemen beyond issuance policies. 4. Spill-overs from public deb managemen o he macroeconomic framework Unil recenly, discussions concerning he coordinaion of macro policies were ofen confined o ineracions beween public deb managemen and moneary- and fiscal policies. Here, we add an explici link beween he former and financial sabiliy by expanding he framework by Togo (2007) (see Figure 2). This secion discusses he spill-overs from public deb managemen o financial sabiliy and moneary policy. Figure 2: Linkages beween public deb managemen and he macroeconomic framework Deb managemen Financial sabiliy Fiscal policy Moneary policy 4.1. Spill-overs from public deb managemen o financial sabiliy As Wheeler (2004) saes, a governmen s deb porfolio is usually he larges financial porfolio in he counry. I ofen conains complex exposures ha creae subsanial risks for he governmen and he counry s financial sabiliy, paricularly where large amouns of foreign currency deb and shor-erm deb are involved. High deb 12 and coningen liabiliies 13 are imporan sources of sovereign risk. A he same ime, deb financing policies play a role in he ransmission of sovereign risk, bu may also become a source of insabiliy on heir own in case financing srucures become very risky. 12 In he euro area, he deb raio has risen from 69% of GDP in 2008 o 85% of GDP in 2010, and is expeced o increase furher o 89% of GDP in 2011 (source: European Commission, 2010 Spring Forecass). 13 According o he European Commission (2010, p 24), coningen liabiliies relaed o governmen inervenions in suppor of he financial secor amouned o 5½% of GDP in 2008 and 8½% of GDP in 2009 in he euro area. 13

17 Wih increasing shares of shor erm deb (in oal), refinancing and rollover risks increase as well, which migh rigger sysemic risks as a resul. In he following, we summarize channels hrough which sovereign risk is ransmied o financial markes boh wihin and across counries. In pracice, all channels a are work simulaneously. Governmen securiies markes ransmi sovereign risks o he holders of governmen deb. In he euro area, moneary and oher financial insiuions hold roughly hree quarers of sovereign deb held by residens. Accordingly, valuaion changes of governmen securiies can quickly spread o he balance shees of financial insiuions. In heory, when invesors hold long erm bonds o mauriy, he effec of valuaion changes will be limied in he shor erm. Wih a sable invesor base, invesors are less likely o pull ou so ha price effecs are likely o be smaller. As a resul, governmens have more ime o address he underlying fiscal problems. In pracice, however, banks hold only very small porions of governmen bonds in heir porfolios o mauriy. 14 The opposie effecs play wih valuaion a marke value, more shor erm deb and a less sable invesor base. In his case, he balance shees of financial insiuions will be more affeced, refinancing will be higher, and invesors will pull ou more quickly. Moreover, increases in ineres spreads will feed back quicker ino governmen fiscal posiions. 15 Therefore, a negaive deb-defici spiral and refinancing problems are more likely, which in urn amplify conagion of sovereign risk o he financial secor. Table 3. Foreign ownership of general governmen deb Belgium Finland Porugal Ausria Ireland Greece Neherlands France Germany Spain Ialy : : : : : : : : : : : : Noes: Daa come from Eurosa, excep for The Neherlands (CBS). Daa for Germany include ex-gdr from Under he Inernaional Financial Reporing Sandards here are hree opions: valuaion a mark-o-marke in he rading book, mark-o-marke in he banking book (available-for-sale), and valuaion a nominal value in he banking book (hold-o-mauriy). The condiions for holding bonds in he hold-o-mauriy book are sric: nohing can be sold, or oherwise he whole porfolio will no longer be hold-o-mauriy. Banks generally hold very small porfolios in he hold-o-mauriy book. 15 Wih more shor erm deb, he sensiiviy of governmen ineres paymens o changes in ineres raes is larger. I could herefore be argued ha an increase in shor erm deb faciliaes marke discipline. Experience however shows ha he effecs of marke discipline ofen come in a non-linear fashion and raher lae. For his reason, we emphasize in he main ex he financial sabiliy risks of shor erm deb. 14

18 In he euro area, financial inegraion due o he single marke and he single currency has led o a sharp increase in foreign ownership of governmen deb (see Table 3). On he one hand, his has broadened he invesor base and increased he efficiency of governmen financing. On he oher hand, i also speeded up he ransmission of shocks o owners of governmen deb in oher counries, hrough he same channels as described above. The ransmission of risk across borders can be furher amplified by correlaed price effecs across counries. If a sovereign is perceived o be riskier, his will be refleced in increased yields on is deb, driving up is funding coss. Counries ha have similar fiscal or economic fundamenals as he risky sovereign are likely o be affeced more. Indeed, we have winessed ha concerns abou Greek fiscal woes were exended shorly no only o balance shees of Greek banks, bu also o perceived risk profiles of Porugal and Spain. Furher, sovereign deb markes are used as a pricing basis for oher financial producs, and ofen have srong correlaions wih oher asse markes e.g. (non-financial) corporae bonds and oher deb insrumens. We conclude ha he impac of deb managemen on financial sabiliy largely depends on he level of deb, he mauriy srucure, ownership and is role as a benchmark. By individually and simulaneously increasing calls on he money marke, euro area deb managers migh have increased risks o financial sabiliy, a a ime when he financial secor is more vulnerable o shocks. Increased spillovers across counries have increased he need for coordinaion of deb managemen pracices. Deb managers need o consider broader effecs of heir financing decisions when issuing deb Spillovers from public deb managemen o moneary policy In describing he spill-overs from public deb managemen o moneary policy, a disincion should be made beween he effec of high deb and deb managemen policies hemselves. Obviously, high deb iself is no he responsibiliy of deb managers. Neverheless, we include i here for compleeness as he level of deb is raher relevan for he way i can be managed and crucial for he link o moneary policy. The radiional argumen is ha high deb may lead o poliical pressure on moneary auhoriies o inflae away par of he deb. As a resul, public percepions of fuure inflaion may change and exer an upward pressure on nominal ineres raes. The empirical relevance of his argumen is however quesionable, as recen research does no find a link beween high deb levels and inflaion in advanced economies (Reinhar and Rogoff, 2010). A relaed 15

19 argumen is ha high deb, especially when financed a shor mauriies, may lead o poliical pressure o keep ineres raes low. Anoher influence of high deb on moneary policy is ha marke urmoil associaed wih increased sovereign risk may hamper he moneary ransmission, as he Greek case has shown. In he euro area, his has led o he Securiies Markes Program hrough which cenral banks direcly bough governmen bonds in marke segmens ha were dysfuncional. 16 A poenial disrupion of he moneary policy ransmission mechanism also followed from he downgrades of Greek bonds. This would have hampered heir eligibiliy as collaeral in moneary policy operaions, and disruped moneary ransmission. As a resul, he Governing Council of he ECB decided o suspend he applicaion of he minimum credi raing of Greek governmen securiies, in ligh of he agreemen on he Greek adjusmen program. Thus, from he perspecive of moneary policy, hese argumens reinforce he need for credible consolidaion and susained fiscal discipline. 17 Public deb managemen, on he oher hand, migh have implicaions for moneary policy hrough is effecs on moneary policy operaions. The ECB implemens is moneary sance by seering he EONIA (he iner-bank overnigh ineres rae). Movemens in he EONIA ransmi o all ineres raes in he whole sale money marke as measured by he EURIBOR. Wih higher shor erm deb issuance, governmens become larger players in he money marke. Their influence on ineres raes migh hen increase and complicae he seering of ineres raes by moneary auhoriies. Such an effec may be larger if several deb offices who individually may be relaively small players ap he money marke simulaneously wihou considering he join effec of heir acions. The relevance of his effec in pracice is an empirical issue ha could be addressed in fuure research. Deb managemen policies can also affec long erm ineres raes. Under normal marke circumsances, such effecs are believed o be generally small. This applies especially o issuance, as mos deb managers aim a predicabiliy in he capial marke. However, in case of increased sovereign risk and refinancing needs, marke funcioning may be less smooh, and deb managemen can have sronger effecs on he yield curve and moneary condiions. 16 Injeced liquidiy was however re-absorbed so ha he moneary policy sance was no affeced. 17 Reducing deb raios is also needed o build buffers for responding o new shocks and given ha high deb levels (i.e. above 90% of GDP in heir approach) are associaed wih lower real economic growh (Reinhar and Rogoff, 2010). 16

20 More generally, ineracion beween deb managemen and moneary policy has also increased a he long end of he marke given ha cenral banks have bough governmen bonds in he secondary marke as par of heir unconvenional moneary policies. As wih ineracions a he shor end of he marke his calls for increased informaion exchange beween deb managers and moneary auhoriies. In his conex, Goodhar (2010, p. 26) argues ha deb managemen is again becoming a criical elemen in he overall conduc of macro economic policy. In his view, cenral banks should be encouraged o rever o heir role of managing he naional deb. Finally, public deb managemen migh inerac wih moneary policy hrough is impac on moneary aggregaes. The broad money sock in he euro area (i.e. M3) is defined by he shor erm liabiliies on he consolidaed balance shee of he money creaing secor (see Table 4). Table 4. Consolidaed balance shee of euro area MFI s Asses Counerpars of M3: Credi o general governmen o.w. loans o.w. securiies Credi o oher euro are residens o.w. loans o.w. securiies oher han shares o.w. shares and oher equiies He exernal asses Liabiliies Componens of M3: Currency in circulaion Overnigh deposis Deposis wih agreed mauriy up o 2 years Deposis redeemable a noice up o 3 monhs Repurchase agreemens Money marke fund shares Deb securiies issued by MFI s wih a mauriy up o 2 years Counerpars of M3: Holdings agains cenral governmen Longer erm liabiliies agains oher euro area residens The money creaing secor consiss of Moneary Financial Insiuions (MFI s) residen in he euro area. In his framework, shor erm refers o deposis and securiies issued by MFI s wih a mauriy of up o wo years. The counerpars of M3 make up he res of he consolidaed balance shee of MFI s (e.g. long erm liabiliies and all asses on he balance shee). I follows from he consolidaed balance shee ha, ceeris paribus, any credi len o he governmen wih any mauriy conribues o an increase in M3. However, acual growh of M3 depends on he ne resul of all he changes in balance shee asses and changes in he mauriy of funding in a given period. In pracice, he conribuion of he governmen o M3 growh has been relaively small since he inroducion of he euro. However, he conribuion increased wih increasing deb levels and has never been as srong as in 2009 and This also calls for informaion exchange beween moneary policy makers and deb managers. 17

21 5. Summary and policy implicaions The increase in deb levels in he euro area has coincided wih increases in boh he level and he share of shor erm deb since This, in urn, has srenghened he iner-linkages of deb managemen wih financial sabiliy and moneary policy. Spill-over effecs across borders have also increased srongly during he pas decade due o capial marke inegraion and increased cross border ownership of public deb. As a response o marke urmoil in governmen deb markes, several counries have sepped up fiscal consolidaion, he EU fiscal rules are being revised, and a emporary crisis mechanism was esablished (i.e. he European Financial Sabiliy Faciliy). As discussed in he previous secion, unsusainable policies are a he roo of he problem. Credible fiscal consolidaion will herefore be a firs necessary sep owards decreasing he effecs of deb managemen on macro policies. In addiion, we believe ha policy aenion is needed for deb managemen policies hemselves. On 2 July 2010, he IMF forum on deb managemen concluded ha he combinaion of high deb and marke volailiy calls for a sronger focus on risk managemen and for enhanced communicaion beween deb managers, fiscal auhoriies and cenral banks. 18 We agree. We see a need for a greaer focus on he effecive risk profiles of public deb porfolios. Our proposals should be seen as a firs conribuion o he ongoing discussion, and would need o be specified furher a a laer sage. As is currenly he case already in cenral banks reserve managemen, broader macroeconomic effecs could be a reason o override consideraion of coss and risks only. Explicily adoping a longer ime horizon for he minimizaion of deb servicing coss in deb managers mandaes can also help o srenghen he focus on risks (for counries which have no ye done so). In addiion, aenion could focus more srongly on he ranslaion of deb managemen mandaes o acual policies. Caps on he level of shor erm deb or refinancing amouns are being used among naional deb managers (Wolswijk and De Haan, 2005). The curren siuaion calls for an inernaional discussion on harmonised caps on shor erm deb and/or refinancing amouns for counries wih high deb. Likewise, a discussion could ake place on he use of derivaives in deb managemen. Swaps can be useful in sraegically managing sovereign deb. However, large posiions in derivaives complicae he risk profile of he deb porfolio and ake away he ransparency. In order o 18 See hps:// 18

22 preven his, limis o he use of swaps (for example, a limi o ousanding swap posiions, exposure o currency swaps and/or a single counerpary ec.) can be inroduced in counries where hey are no in place. When collecing daa for he empirical par of his paper, we were sruck by he fac ha no cross counry daa were available on he use of swaps and he resuling mauriy srucures. In our view, naional deb managers should co-operae o improve daa availabiliy and comparabiliy across counries. Doing so would also assis he European Commission in including deb managemen as par of fiscal surveillance in he conex of he EU fiscal framework. Moreover, aligning and pooling informaion would faciliae he exchange of informaion beween deb managers in he euro area and he European Sysemic Risk Board on financial sabiliy and he ECB on moneary policies. REFERENCES Barro, R. J. (1999), Noes on Opimal Deb Managemen, Journal of Applied Economics, Vol. 2, pp Blommesein, H.J., Gok, A. (2009), The Surge in Borrowing Needs of OECD Governmens: Revised Esimaes for 2009 and 2010 Oulook, OECD Journal: Financial Marke Trends Bohn, H. (1998), The Behaviour of U.S. Public Deb and Deficis, The Quarerly Journal of Economics, Vol. 113, pp Cassard, M., Folkers-Landau, D. (1997), Risk Managemen of Sovereign Asses and Liabiliies, IMF Working Paper, WP/97/166 Currie, E., Dehier, J.J., Togo, E. (2003), Insiuional Arrangemens for Public Deb Managemen, World Bank Policy Research Working Paper, No European Commission (2010), Public Finances in EMU, European Economy 4 Fabozz F. J. (2010), Bond Markes, Analysis and Sraegies, Pearson Inernaional Ediion, New Jersey Goodhar, C.A.E. (2010), The Changing Role of Cenral Banks, Paper for 9h BIS Annual Conference IMF and he World Bank (2003), Guidelines for Public Deb Managemen Joyce, M., A. Lasaosa, I. Sevens and M. Tong (2010), The Financial Marke Impac of Quaniaive Easing, Bank of England Working Paper 393 Missale, A. (2000), Opimal Deb Managemen wih a Sabiliy and Growh Pac, Public Finance and Managemen, Vol. 1(1), pp Piga, G. (2001), Derivaives and Public Deb Managemen, ISMA, Zurich Reinhar, C. M., Rogoff, K. S. (2010), Deb and Growh Revisied, hp:// 19

23 Taylor, J.B. (1993), Discreion versus Policy Rules in Pracice, Carnegie-Rocheser Conference Series on Public Policy, Vol. 39, pp Tobin, J. (1963), An Essay on Principles of Deb Managemen, Fiscal and Deb Managemen Sudies, Englewood Cliffs, pp Togo, E. (2007), Coordinaing Public Deb Managemen wih Fiscal and Moneary Policies: An Analyical Framework, World Bank Policy Research Working Paper, No Wheeler, G. (1997), Sovereign Deb Managemen in New Zealand, in Kari Nars, ed, Excellence in Deb Managemen : The Sraegies of Leading Inernaional Borrowers. Euromoney Publicaions, 1997 Wheeler, G. (2004), Sound Pracice in Governmen Deb Managemen, Washingon, D.C. Wolswijk, G., de Haan, J. (2005), Governmen Deb Managemen in he Euro Area: Recen Theoreical Developmens and Changes in Pracices, ECB Working Paper, No