Essays on sovereign debt holdings and macro-financial linkages

• Main Author: Quiroga Trevino, Miroslava
• Format: Dissertation
• Language: English
• Published: University of Sheffield 2022

This thesis consists of three essays that analyse sovereign debt holdings in the balance sheets of the financial sector, which comprises both financial institutions and a central bank. The first essay deals with how sovereign leverage can have an impact on economic activity through a balance sheet channel of fiscal policy and studies the implications on credit markets and real economic activity when banks are subject to minimum capital requirements. By employing a dynamic stochastic general equilibrium model (DSGE) estimated with Bayesian techniques for the European periphery, this work highlights that the financial sector, being the largest holder of sovereign debt, propagates the effects of a debt-financed fiscal policy on the real business cycle through credit displacement and investment contraction. The second essay examines European bank exposures to domestic sovereign debt and the implications on real activity under a recomposition in their balance sheets. The research focuses on the transmission channel of fiscal shocks on credit supply and capital formation in six of the largest European Monetary Union countries using a Structural Bayesian Panel Vector Autoregressor (SBPVAR) from 2003-2019. Results suggest that debt shocks increased the exposure of domestic financial institutions to sovereign debt and instigated credit displacement, leading to lower capital formation in European economies, where the effects appeared more pronounced for peripheral economies. The final essay develops a DSGE model to analyse the impact of Large Scale Asset Purchases (LSAPs) of government securities on financial and real variables to analyse the effect on economic activity using the European Union as the case of study. Regulatory measures capturing macroprudential regulation set a limit on the minimum capital ratios that financial institutions must meet which in turn influence credit provision. This essay analyses the interaction of fiscal, monetary and macroprudential policies and suggests that unconventional monetary measures alleviate pressures on the banking sector that consequently incites credit provision. By increasing demand of government securities, the central bank eases banks' balance sheets, reducing the cost for financial intermediaries which further pass that into lower credit costs for private firms to incentivize their investment decisions. The model features occasionally binding constraints to evaluate the role of LSAPs in the presence of the Zero Lower Bound (ZLB) for short term rates, showing that the effects on the economy are amplified when the lower bound binds. The results of this thesis suggest that to the extent that the banking sector generates a primary market for sovereign bonds, it leads to a lower credit supply, which is reflected in lower levels of credit and investment. On the other hand, unconventional measures in the form of LSAPs implemented by central banks, lead to relax the balance sheet of commercial banks, which facilitates credit to the productive sector and minimizes the crowding out effect of the debt on private investment.