The European Sovereign Risks and Monetary Policies

(Abstract)

Here we analyze, with the Greek fiscal crisis in mind, monetary policies by using the model of the single currency zone containing national governments issuing bonds with sovereign risks. The model is an application of the fiscal theory of price level. Under the hypothesis of the presence of governments issuing bonds with sovereign risks, the Ricardian equivalence theorem does not necessarily hold. Under the Taylor’s rule, therefore, when exogenous shocks worsening nations’ fiscal balances break out, the outstandings of bond issuance will go up without limit, prolonging the default period. On the other hand, under the interest rate rules bringing risk assets interest rates in line with the policy interest rates and fixing them at a steady-state level, a default situation comes to an end in just a single term. And government bond swap operations further stabilize the inflation rates and GDP gaps. Although the indeterminacy on rational expectation equilibrium occurs under Taylor’s rule, government bond swap operations always guarantee the deterministic equilibrium. Therefore, government bond swap operations are the policy that should be adopted in Europe, where fiscal crises and inflation concerns coexist.

Key words: sovereign risks, European crisis, fixed interest rate rule, the fiscal theory of price level

JEL Classification: E52，E60，F41，F47

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The Sovereign and Financial Crisis and the Change of the System of the Euro

(Abstract)

It is now apparent that the “original system of euro” that was stipulated in the Maastricht Treaty, or the Treaty on European Union, cannot cope with the euro crisis that began in 2009. The ECB (European Central Bank) was faced with difficulties in dealing with the crisis because the stabilization of financial order is not included in the obligations of the ECB. And the collective responsibility, or the mutual fiscal aid among the euro zone countries, and the direct purchase of government bonds by the ECB are categorically denied in the Treaty. Where did this unique self-responsibility system originate from? How did it put obstacles in responses of the actors to the euro crisis? And how did the ECB and the euro zone countries, nevertheless, overcome those obstacles and go ahead with the de-facto reform of the system? These are our themes here. And finally we summarize the ongoing changes in the system of euro prompted by the crisis, and also present a sketch on the reform of the system of euro in the near future.

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Sovereign Risk and Exchange Rate Systems - Implications from Europe's Experience

(Abstract)

A country's "sovereign risk" can rise irrespective of the exchange rate system it chooses to adopt.

Yet the choice of exchange rate regime can affect the country's economic stability. One of the euro’s important goals was to take away easy choices and push forward structural reforms. The euro is in crisis because this goal was not achieved. Without reforms, giving up the single currency will not ensure sustainable prosperity. Euro area countries are highly interdependent, and exchange rate fluctuations harm economic activities. Integration is the only way to have peace and prosperity in Europe. For all these reasons, euro area countries had and have reason to join the euro.

Europe is tackling the question of how much sovereignty must be given up for the sake of successful integration and sustainable prosperity. It is the first in the world to do so, providing invaluable lessons for Asia and others. As globalisation continues, all economies will eventually face this choice, in particular the choice between "stable exchange rates" and "the right to have autonomous monetary and fiscal policy", or "the right to be different".

Key words: sovereign risk, euro, structural reforms

JEL Classification: F41, F55, E61

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The European Sovereign Risks – The Knock-on Effects of Default Risks across Public and Financial Sectors

(Abstract)

The European financial situation is so serious that it is reminiscent of the so-called “Lehman Shock” in 2008. Member countries of Europe can be more susceptible to ripple effects triggered by outbreak of credit crisis in a part of the region because of the following reasons. Europe has a dominant share of financial transactions within in the region, and the regional sovereign risks may spread to the neighboring countries through its securities investment and lending. And there is also a concern that the financial system instability may harm the fiscal health of those countries as a result from tax revenue reduction due to economic slowdown caused by credit crunch, public fund injection into financial institutions, and so on. The foundation of the European Financial Stabilization Mechanism meant an additional route through which a fiscal crisis breaking out in one country in the region may spread to the entire European region.

Here we take into consideration the mutual interdependence among the countries as well as the one between the financial and public sectors, and examine the features of the knock-on effects of the crisis within the European region. Since the foundation of the European Financial Stabilization Mechanism, the knock-on effects among the euro zone’s core countries have been dramatically heightened, and our research suggests that those knock-on effects have been amplified through the concerns about the instability of the financial system. On the other hand we cannot detect the knock-on effects from the Greek sovereign CDS, or Credit Default Swap, that had shown an extraordinary soaring, which we attribute to the shrinking market liquidity against the background of the tighter regulations on CDS transactions and the confusions regarding the certification of credit events. And even among the core countries, the knock-on effects of the sovereign risks on the CDS of the German financial institutions were light, and we may attribute it to the “flight-to-quality” phenomenon having an impact of lowering the German sovereign CDS premiums.

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The Contagion of the Greek Fiscal Crisis and the Structural Changes of the Euro Sovereign Bond Markets

(Abstract)

By using the data of the EURO sovereign bond yields since January 2007, this article analyzes the recent development in the Euro sovereign bond markets where the successive contagion of the financial crisis has been evolving, with particular focus upon the crisis contagion and the structural changes in the market. We take up the following four issues.

First, we regard the two junctures, where the new Greek government announced the upward revision on their fiscal deficit triggering the market frenzies, and where the framework of 750 billion euro financial assistance was agreed upon, as the major turning points and examine by dummy variables whether structural changes occurred in the markets at these two occasions. Second, assuming that the timing of structural change is unknown, we examine the difference in the timing of structural changes among the countries. Third, we prove by using the Dynamic Conditional Correlation Multivariate (DCC-M) GARCH model that the correlation among the EURO sovereign bond yields notably lowered after the Greek crisis broke out. Fourth we examine the propagation of the hiked bond yields and increased volatility from the crisis-ridden Greece, Portugal and Ireland to other countries by applying the tests on Causality-in-Mean and Causality-in-Variance.

We draw up the following four conclusions. First, the hypothesis that all the European countries went through structural changes at the aforementioned two points is not statistically supported, which suggests that even in the single currency zone the timing of structural change may differ depending upon each country’s economic situation. Second, assuming that the timing of structural change is unknown, we confirm that the European government bond markets went through various shocks since 2007 which result in the intermittent changes in the parameters in the yield model. Third, we confirm that in the period leading up to the so-called “Lehman Shock,” the correlations between the German sovereign bond yields and those of the other euro countries were generally high but after the Lehman Shock, correlation with the German bonds gradually lowered for the yields of the bonds of Greece, Ireland, Portugal and Italy. This result implies that a certain single event did not lead to the turning point for the correlations among the whole Euro zone countries but that the timing of turning point differs country by country. Fourth the results of the Causality-in-Mean and the Causality-in-Variance tests indicate that while the former tends to be detected at the early stages, the latter is running late in appearing. We confirm from the results of these causality tests the contagion of the Greek shock to the major EURO countries such as Spain, Italy, France and Germany.

Key words: euro fiscal crisis, structural changes, causality tests, DCC M-GARCH

JEL Classification: C53, E43

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How Strongly Do “Financing Constraints” Affect Firm Behavior?: Japanese Corporate Investment since the Mid-1980s

(Abstract)

Research on Japanese corporate finance typically starts from the premise that banks decisively affect corporate behavior. Crucial to this premise in the Japanese context are two claims: that the strength of a firm’s relationship with a specific bank (and the funds that the bank makes available to it) determines its financing constraints, and that those constraints decisively condition the way it behaves.

Using firm-level data from the Corporate Enterprise Annual Statistics, I ask whether financing constraints significantly affected corporate investment in land and other fixed assets. I take firms in the real-estate-related industries and for comparison the manufacturing industry, and examine their investments during 1983-2009. The data suggest two conclusions. First, financial constraints did not significantly affect medium- and long-term investment in equipment. Second, most firms have not faced serious financial constraints during the decades since 1983. Many scholars argue that such constraints contributed both to the “Bubble” during the second half of 1980s and the following recession since the 1990s, the “Lost Two Decades”. The data, however, show no evidence that financing constraints prevented firms from investing in real estate or other tangible fixed assets.

These conclusions are consistent with those in other papers by Miwa, including Miwa [2011a]. They raise serious questions about the premises relating to Japanese financial markets that many scholars bring to their study of the Japanese economy. Investigating empirically the effectiveness of “financing constraints”, they also have important implications for current research into macro-economic fluctuations.

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