Using unique tick-by-tick data from an exchange, this paper examines the relationship between the US dollar and liquidity in the Korean government (Treasury) bond market. We find that a strong US dollar deteriorates the Treasury market's liquidity by increasing the bid-ask spread and the price impact and lowering market depth. The effects of fluctuations in the broad US dollar index on Treasury market liquidity become more pronounced when funding liquidity conditions are tighter, when banks' total capital ratio is lower with greater foreign currency risk, or when there is a larger sell-off of Korean Treasury bonds by foreign investors. The empirical evidence supports the financial channel of exchange rates affecting Treasury market liquidity. In particular, a strong dollar as a global risk factor is likely to limit the market intermediation capacity of emerging market dealers through the currency exposures of borrowers or dealers and thus tighten market conditions.

Do governments in Latin America tend to be optimistic when preparing budgetary projections? We address this question by constructing a novel dataset of the authorities’ fiscal forecasts in six Latin American economies, using data from annual budget documents over the period 2000–2018. We compare such forecasts with the outturns reported in the corresponding budget documents of the following years, to understand the evolution of fiscal forecast errors. Our findings suggest that: (i) there is no general optimistic bias in the forecasts for the fiscal balance-to-GDP ratio; (ii) over time, fiscal forecasts have improved for some countries and worsened for others; (iii) forecast errors for the fiscal balance-to-GDP ratio are positively correlated with GDP growth and terms-oftrade changes, and negatively correlated with GDP deflator surprises; (iv) forecast errors for public debt-to-GDP ratios are negatively associated with surprises to GDP growth; and (v), budget balance rules may help contain fiscal forecast errors.

This paper examines whether prudential policies help to reduce sovereign bond vulnerability to global spillover risk in ASEAN-4 countries (Indonesia, Malaysia, the Philippines, and Thailand). We measure sovereign vulnerability within a risk connectedness network among sovereign bonds. The direct effect is that markets with tighter prudential policies have significantly smaller spillovers from the Treasury yield shocks of other regional and global economies. The sum of indirect and direct effects indicates that prudential policies reduce sovereign spillover risk in the long term. These findings suggest prudential policies have dual efficiency in sovereign risk regulation and Treasury internationalization.

The feedback loop between sovereign and financial sector insolvency has been identified as a key driver of the European debt crisis and has motivated an array of policy proposals. We revisit this “doom loop” focusing on governments’ incentives to default. To this end, we present a simple 3-period model with strategic sovereign default, where debt is held by domestic banks and foreign investors. The government maximizes domestic welfare, and thus the temptation to default increases with externally-held debt. Importantly, the costs of default arise endogenously from the damage that default causes to domestic banks’ balance sheets. Domestically-held debt thus serves as a commitment device for the government. We show that two prominent policy prescriptions – lower exposure of banks to domestic sovereign debt or a commitment not to bailout banks – can backfire, since default incentives depend not only on the quantity of debt, but also on who holds it. Conversely, allowing banks to buy additional sovereign debt in times of sovereign distress can avert the doom loop. In an extension we show that in the context of a monetary union (such as the euro area) similar unintended negative consequences may arise from the pooling of debt (such as European safe bond aka. ESBies). A backstop by the central bank (such as the ECB’s Transmission Protection Instrument) can successfully disable the loop if precisely calibrated.

We empirically analyze the interaction of monetary policy with financial stability and the real economy in the euro area. For this, we apply a quantile vector autoregressive model and two alternative estimation approaches: simulation and local projections. Our specifications include monetary policy surprises, real GDP, inflation, financial vulnerabilities, and systemic financial stress. We disentangle conventional and unconventional monetary policy by separating interest rate surprises into two factors that move the yield curve either at the short end or at the long end. Our results show that a build-up of financial vulnerabilities tends to be accompanied initially by subdued financial stress which resurges, however, over a medium-term horizon, harming economic growth. Tighter conventional monetary policy reduces inflationary pressures but increases the risk of financial stress. We find unconventional monetary policy to be similarly effective in reducing inflation, but with a lower adverse effect on growth and financial stress. Tighter unconventional monetary policy is also found to have a dampening effect on the build-up of financial vulnerabilities.

Three years after the onset of the COVID-19 pandemic, countries in Latin America and the Caribbean (LAC) are still dealing with its economic consequences. Currently, one of the main points of concern is the excessive level of public indebtedness and the risk it represents to economic stability and economic growth. This year the IDB published its flagship study Development in the Americas – Dealing with Debt: Less Risk for More Growth in Latin America and the Caribbean. It shows that the pandemic accelerated the pace of public indebtedness and slowed economic growth in the region, a trend that had already been emerging in previous years. Since 2020 public debt levels rose by 15 percentage points (pp) of the region’s gross domestic product, to 71 percent. That adds up to the 18-percentage point increase between 2014 and 2019. Unfortunately, increased debt has not helped boost growth nor overall economic productivity. Figure 1 below shows that economic growth has been slowing down in the region because of a reduction in total factor productivity, especially of labor and capital. Economic growth in the region has gradually slipped to a mere average of 2 to 2.5% in the medium term. […]

We assess the drivers of fiscal sustainability in Portugal during the period 1999Q4-2021Q4. We resort to expanding window and Schlicht (2003, 2021)’s time-varying approaches to construct the responses of government revenues to government expenditures and the responses of the primary government balance and the cyclically adjusted primary government balance (CAPB) to the debt-to-GDP ratio. Our results show the prevalence of a Ricardian fiscal regime in Portugal. If the (i-g) differential is positive, the positive response of the primary government balance to the debt-to-GDP ratio is amplified. An improvement in the external accounts, the increase in the European Commission's fiscal rules index and the extension of the debt maturity were beneficial for fiscal sustainability. Sovereign debt rating downgrades implied a posterior fiscal reaction that improves fiscal sustainability. Moreover, fiscal sustainability increased during the implementation of the international financial assistance program to Portugal, between 2011Q2 and 2014Q2.

Although the European Union (EU) has implemented initiatives and common rules regarding securities settlement, no similar integration initiatives have been proposed for the issuance and initial distribution of debt securities. For this reason, the EU does not function as a single market given that issuers of euro debt instruments still have to use multiple and non-harmonised channels and procedures. A harmonised European framework for the issuance and initial distribution of debt securities or the establishment of a new European market infrastructure service is widely considered to create a deep and liquid single market for debt instruments. Although such paradigm shift promises significant improvements compared with the existing debt issuance and distribution landscape, a hasty and poorly-designed public intervention would risk distorting the market, thereby increasing complexity and leading to more fragmentation.

We examine yield spreads of government debt issues from countries that have received large-scale debt relief through the Heavily Indebted Poor Countries (HIPC) program and the Multilateral Debt Relief Initiative (MDRI). Using data from more than 3,000 bonds issues and after controlling for macroeconomic, political, and geographical factors, we find that HIPC governments pay an average yield spread premium of close to 1.5\% on USD-denominated and non-USD-denominated bonds compared to similar countries which have not received relief. Despite the extent of the relief and the significant conditions attached to it, the market perception is that relieved countries remain riskier.

We analyze domestic, foreign, and central banks holdings of public debt for 31 countries for the period of 1989-2022, applying panel regressions and quantile analysis. We conclude that an increase in sovereign risk raises the share of domestic banks’ portfolio of public debt and reduces the percentage holdings in the case of central banks. Better sovereign ratings also increase (decrease) the share of commercial (central) banks’ holdings. Furthermore, the effects of an increment in the risk for domestic investors have increased since the 2010 financial crisis.

The actions of funds speculating in sovereign debt, frequently nicknamed “vulture funds”, are often roundly criticized. These funds purchase distressed debts on the secondary market at reduced prices and then seek payment in court at face value plus interest and fees. Although their actions are legally justified, so-called “vulture funds” are vilified due to the negative impact of their activities on sovereign debtors and their population. While there is a strong demand for regulating sovereign debt speculation, various solutions already exist but are, in many ways, insufficient. This article argues for the adoption of a tailored regulation of the speculative phenomenon by the United States. The article explains that sovereign debt sustainability is the only standard that can ensure the balance between the rights of creditors and the proper functioning of debtor states. This argument justifies the regulation of speculative activities as well as the magnitude that this regulation should take.

This study investigates the stabilizing role of small and medium-sized local banks and assesses whether high local government debt levels hinder this role. Using bank-level data for all provinces in China, 2015–2021, we find that the lending behavior of small and medium-sized banks is countercyclical when located in provinces with low levels of local government debt but procyclical when located in provinces with high levels of local government debt, particularly during busts. This finding suggests that high levels of local government debt hinder the stabilizing role of small and medium-sized banks, exacerbating regional economic volatility.

The Stanford Municipal Finance Dashboard is an original resource to provide financial fundamentals for all state governments and the 500 largest local governments in the United States. We summarize the financial position of public entities by several important financial metrics similar to the practice in the corporate finance context. These metrics have been largely missing for public entities. We close this gap by publishing these indicators and provide an aggregate financial strength score for all state governments and the largest local governments in the United States. This document describes the methodology that we use.

This study investigates how differently have the CDS spreads of EMU core, EMU periphery, and non-EMU economies evolved in the progress of the Global Financial Crisis (GFC) and the Eurozone Debt Crisis (EDC). We employ AR-X-GARCH-copula models to analyze the heterogeneous patterns in the movements of the CDS spreads across the three groups and two crises. We find that the value of EUR among the common determinants has asymmetric effect on the EMU periphery group and the others. Furthermore, only Greece and Ireland experiences structural changes in the conditional means after controlling for the common determinants. In terms of conditional volatility, the three groups exhibit similar structural increases during the GFC, however, the EMU periphery group shows obviously larger increment than the others in the EDC period. As a result of the dependence analysis, we find (EMU core, EMU core) and (non-EMU, non-EMU) pairs generally experience structural increase in both the Gaussian and tail dependences during the two crises. However, (EMU periphery, EMU periphery) overall exhibits no or structural decrease in dependence. Lastly, the asymmetry in dependence becomes more skewed to the lower tail for the GFC period whereas it stays similar for the EDC period, in general.

This article discusses the links between climate and debt sustainability by focusing on how climate mitigation and adaptation are paid for, and who pays for it. This requires thinking about instruments such as sovereign bonds, carbon credits, conditional official grants and debt relief from both public and private sources. The article discusses the role of green bonds, carbon offsets, grants and debt relief. Among these solutions, no single instrument appears to be right for all countries or at all times. To move forward, we make six proposals and policy recommendations that can jointly address climate change and debt sustainability.

The unprecedented rise in debt levels across countries has given rise to the role of institutions on public debt. This study examines the impact of institutions on government debt in a sample of 54 EU and non-EU economies, covering the 2010 to 2020 period. Employing the Logistic Quantile Regression (LQR) method, we examine whether institutions affect countries equally, when they have low debt levels (are at the lower end of the distribution) compared to countries with high debt levels (are at the higher end of the distribution). Our results indicate that the effect of institutions varies across the distribution of debt. The results suggest that government effectiveness, the control of corruption and the rule of law has a significant impact on countries with low levels of debt in EU nations. In non-EU nations in contrast, government effectiveness, the rule of law and the regulatory quality has the highest impact when debt levels are around their median level. Several robustness checks confirm our findings.

The market for U.S. government debt (Treasuries) forms the bedrock of the global financial system. The ability of investors to sell Treasuries quickly, cheaply, and at scale has led to an assumption, in many places enshrined in law, that Treasuries are nearly equivalent to cash. Yet in recent years Treasury market liquidity has evaporated on several occasions and, in 2020, the market’s near collapse led to the most aggressive central bank intervention in history.

This Article pieces together what went wrong and offers a new account of the relationship between money issue and debt issue as mechanisms of public finance. It argues that a high degree of convertibility between Treasuries and cash generally requires intermediaries that can augment the money supply, absorbing sales by expanding their balance sheets on both sides. The historical depth of the Treasury market was in large part the result of a concerted effort by policymakers to nurture and support such balance sheet capacity at a collection of nonbank broker-dealers. In 2008, the ability of these intermediaries to augment the money supply became impaired as investors lost confidence in their money-like liabilities (known as repos). Subsequent changes to market structure pushed substantial Treasury dealing further beyond the bank regulatory perimeter, leaving public finance increasingly dependent on high-frequency traders and hedge funds—”shadow dealers.” The near money issued by these intermediaries proved highly unstable in 2020. Policy makers are now focused on reforming Treasury market structure so that Treasuries remain the world’s most liquid asset class. Successful reform likely requires a legal framework that, among other things, supports elastic intermediation capacity through balance sheets that can expand and contract as needed to meet market needs.

Climate change disproportionately impacts capital and output in low- and middle-income countries (LMICs). Limited fiscal space and high dependence on capital good imports further curtail their ability to make timely climate-resilient investments. In this paper we present a demand-driven model that is supply-side constrained due to insufficient build up of production capacity. Calibrating the model to Fiji, we evaluate growth pathways for three climate futures – 2C, 3C, and 4C global warming by the end of the century. We evaluate the role of a public climate fund to enable partial recovery that is financed through four different schemes - debt-led recovery, higher tax on households, higher taxes on capitalists, and unconditional grants from the rest of the world. Recovery is possible in the 2C scenario, but the 3C and 4C scenarios increasingly face higher investment costs in the face of lower growth and saving rates. In the 4C scenario, even the most generous unconditional grants scheme fails to prevent the downward spiral of hitting capacity constraints despite an initial boost to output. These insights underscore the need for effective and equitable domestic climate policies and affordable finance and compensation to support sustainable development in vulnerable countries.

The purpose of this paper is, first, to identify and distinguish the different trajectories of the relationship between industrial policy and sovereign debt, tapping on historical examples from Germany and Egypt. It then provides a brief analysis and legal assessment of each identified trajectory, namely the debt implications of foreign investments made in pursuance of industrial policies; and the implications of the sovereign debt regime on industrial policies in debtor states. The paper concludes with some recommendations for international institutions and courts.

This paper revisits the debate on the design of fiscal rules in resource-rich countries. Its main objective is to assess alternative systems of rules against their policy objectives, while taking into account country characteristics. One of the contributions of the paper is to propose fiscal frameworks that are centered around the principle of insurance against shocks and less reliant on estimating precisely resource wealth, which tends to be highly volatile.