Addressing weak inflation: The European Central Bank's shopping list. Bruegel Policy Contribution 2014/05, May 2014

There are clear benefits to price stability. High inflation can distort corporate investment decisions and the consumption behaviour of households. Changes to inflation redistribute real wealth and income between different segments of society, such as savers and borrowers, or young and old. Price stability is therefore a fundamental public good and it became a fundamental principle of European Economic and Monetary Union. But the European Treaties do not define price stability. It was left to the Governing Council of the European Central Bank (ECB) to quantify it: "Price stability is defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%"[1]. The Governing Council has also clarified that it aims to maintain inflation below, but close to, two percent over the medium term, though it has not quantified what 'closeness' means, nor has it given a precise definition of the 'medium term'[2]. The clarification has been widely interpreted to mean that the actual target of the ECB is close to, but below, two percent inflation in the medium term.

ECB Policy and Eurozone Fragility: Was De Grauwe Right? CEPS Working Document No. 397, June 2014

Paul De Grauwe’s fragility hypothesis states that member countries of a monetary union such as the eurozone are highly vulnerable to a self-fulfilling mechanism by which the efforts of investors to avoid losses from default can end up triggering the very default they fear. The authors test this hypothesis by applying an eclectic methodology to a time window around Mario Draghi’s “whatever it takes” (to keep the eurozone on firm footing) pledge on 26 July 2012. This pledge was soon followed by the announcement of the Outright Monetary Transactions (OMT) programme (the prospective and conditional purchase by the European Central Bank of sovereign bonds of eurozone countries having difficulty issuing debt). The principal components of eurozone credit default swap spreads validate this choice of time frame. An event study reveals significant pre announcement contagion emanating from Spain to Italy, Belgium, France and Austria. Furthermore, time-series regression confirms frequent clusters of large shocks affecting the credit default swap spreads of the four eurozone countries but solely during the pre-announcement period. The findings of this report support the fragility hypothesis for the eurozone and endorse the Outright Monetary Transactions programme.

Disappearing government bond spreads in the eurozone - Back to normal? CEPS Working Document No. 396, May 2014

Since the announcement of the Outright Monetary Transactions (OMT) programme by Mario Draghi, President of the ECB, in 2012, the government bond spreads began a strong decline. This paper finds that most of this decline is due to the positive market sentiments that the OMT programme has triggered and is not related to underlying fundamentals, such as the debt-to-GDP ratios or the external debt position that have continued to increase in most countries. The authors even argue that the market’s euphoria may have gone too far in taking into account the same market fundamentals. They conclude with some thoughts about the future governance of the OMT programme.

The Determinants of Country Risk in Eastern European Countries. Evidence from Sovereign Bond Spreads. Bruges European Economic Research (BEER) Papers 8/November 2006

The paper studies country risk in two Central and Eastern European countries - Bulgaria and Poland. The long run relationship between the yield differential (spread) of Eastern European national bonds (denominated in US dollars) over a US Treasury bond on one the hand and the country’s fundamentals as well as an US interest rate on the other hand, is examined. The cointegrated VAR model is used. First, the yield differentials are analyzed on a country by country basis to extract stochastic trends which are common for all bonds in a given country. Thereafter, the risk is disentangled into country and higher level risk. This paper is among the first ones which use time series data to study the evidence from sovereign bond spreads in Eastern Europe.

Time for the ECB to bite the bullet. CEPS Commentary, 19 January 2015

This Commentary summarises the main reasons why the ECB can no longer delay launching a massive bond-buying programme, also including sovereigns of eurozone member countries, and why such interventions will indeed be effective in raising inflation, thus restoring the ECB’s credibility and spurring economic activity. A credible programme must continue either until an explicit inflation target has been achieved or the ECB balance sheet has reached the €2 trillion target already announced by the ECB’s Governing Council. Regardless of how such interventions will be undertaken, they will reduce interest-rate spreads between eurozone markets, but it is nevertheless important that the ECB designs its operations so as to avoid any implication of direct support or deficit financing facilitation for the eurozone’s most indebted countries. Finally, some kind of guarantee against first losses by the ECB on its sovereign bonds may be appropriate, while entrusting open market operations to each national central bank for their own sovereigns could threaten the very survival of monetary union.