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European
Economic Perspectives 24
Dealers’
Choice
Within
Euroland, all government debt is now denominated in euros. Liquidity and
default risk are the only remaining determinants of yield differentials.
What does this imply for the management of public debt under EMU?
With
the advent of EMU, government securities in the Euroland countries have
been redenominated in euros. Speculative demand and the demand for
portfolio diversification related to exchange rate variation have
disappeared and the common euro denomination has made liquidity and
default-risk the only dimensions on which securities issued by different
EMU members can be distinguished.
The
prospect of EMU has already increased competition among governments in
selling debt. This has led them to enact policies that increase the
attractiveness of their securities by enhancing liquidity and
transparency, such as the promotion of benchmark bonds and the
introduction or extension of issue calendars. The advent of EMU has also
affected the incentives of issuers, with changes in selling techniques
and in their relationships with primary dealers and market-makers, aimed
at ensuring their services for the promotion of national bonds abroad.
If competition is increasing, the outcome of this process for financial
integration and monetary policy remains uncertain.
In
the third title in CEPR’s new Policy Paper series, Carlo Favero,
Alessandro Missale and Gustavo Piga analyse changes in public debt
management under EMU and its implications for monetary policy. Their
Paper stresses two effects of EMU on debt management:
•
Competition will lead to increasingly liquid markets for government
securities, with large volumes of outstanding issues, the creation of
markets for strippable bonds and further convergence of debt structures
and debt maturities. This activity is beneficial: it will lead to more
financial integration and it eases the task of monetary policy in
controlling liquidity and transmitting monetary policy impulses.
•
Competition will, however, also lead to non-cooperative primary issuing
policies, with concessions to primary dealers at the expense of
taxpayers and the abandonment of auction techniques, putting at risk the
transparency and regularity of the issuing process. Competition may also
favour a discretionary approach to the choice of issue dates so as to
take advantage of temporary liquidity in the market. This may complicate
the task of monetary policy and worsen the quality of available
information by adversely affecting price formation and discovery.
The
Report calls for action by the European Commission to promote
cooperation and coordination of debt-issuing policies across EMU
members. In particular, the Report makes a number of recommendations for
primary debt markets:
•
Coordination on dates of issuance should be the focus of debate within
Euroland. A supranational institution should discourage bunching among
the big players, as Germany has done internally.
•
The primary dealers’ requirements and advantages in the primary
markets have undergone several reforms that might be a signal of the
increased relative power of market-makers in a world where national
issuers have decided not to cooperate. This raises the question of the
cost of issuing fixed-income bonds and should generate further
examination of alternative issuing strategies. Fees to primary dealers,
for example, should be accounted for in the level of interest
expenditures so as to make debt managers more attentive to the indirect
costs of their operations.
•
Large countries should continue to use auctions, but they should keep in
mind that market-makers bear investment risk during them. This implies
that auctions should not be cancelled after being announced unless a
major negative event occurs, and they should not be cancelled after bids
have been entered. (A sufficiently tight quantity range, communicated
before the auction is started, could help to avoid such cancellations).
•
Small countries that struggle to achieve liquidity may consider
alternatives, such as syndicated loans and/or tap systems – at the
cost of transparency – as these systems achieve greater visibility and
greater flexibility. But as with auctions, issuance dates should be
communicated largely in advance to reduce the temptation to use these
alternatives only in favourable conditions.
This
article discusses ‘EMU
and Public Debt Management: One Money, One Debt?’ (CEPR
Policy Paper No. 3, January 2000) by Carlo Favero, Alessandro
Missale and Gustavo Piga. Carlo Favero is at IGIER, Università Bocconi,
Milano and a CEPR Research Fellow; Alessandro Missale is at Università
di Firenze; and Gustavo Piga at Università di Macerata.
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