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Financial downgrading and monetary policy asymmetries
Mon, Feb 2 2009, 16:12 GMT
by Søren Dijohn
• In a process ignited by the financial downgrading of some European countries by the rating agencies, EMU bond yield spreads have widened recently. The countries that have been downgraded are also those with the largest imbalances and therefore where the largest deterioration in government budgets is anticipated and the perceived risk greatest.
• We present a set of striking correlations indicating that the recent financial downgrading and widening of spreads relative to German bunds relates to economic policy during the period between 2002 and 2007. Therefore, recent financial downgrading appears to be closely connected to lax economic policy and lack of structural improvements in preceding years.
• For some member countries, including Greece, Ireland and Spain in particular, monetary policy rates set to be consistent with conditions in the euro area as a whole were persistently and significantly below that prescribed by a "country-focused" Taylor rule. Large asymmetries have not been offset by a sufficiently tight fiscal policy and/or structural improvements, and have consequently been allowed to have real economic effects, for example, through the booming housing market.
• This is also a lesson for the future. Politicians in all euro countries still have an obligation to run their own country to the best of their ability. They have to secure long run sustainable growth through appropriate fiscal policy and structural improvements. The euro is not a substitute for appropriate and timely policies at national level - there is no free lunch.
Published on Mon, Feb 2 2009, 16:16 GMT
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