Abstract
The present article examines 10-year bond yields convergence between each of the new EU countries and Germany, including a structural break that embodies the effects of the current sovereign debt crisis in the Eurozone. The analysis is based on a new definition of bond yields convergence that can be interpreted either as strong or weak monetary policy convergence, depending on whether the conditions of uncovered interest-rate parity and ex-ante purchasing power parity hold or are violated, respectively. The empirical results provide evidence of either strong or weak monetary policy convergence to Germany only for five new countries, namely Croatia, the Czech Republic, Lithuania, Romania and Slovakia. In contrast, for the rest of the new EU countries the empirical evidence suggests lack of monetary policy convergence to Germany. The latter result could be probably explained by the increased risk premia in these countries, as a result of the Eurozone sovereign debt crisis.
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Notes
In fact, Slovenia adopted the euro in January 2007, followed by Cyprus and Malta in January 2008, Slovakia in January 2009, Estonia in January 2011, Latvia in January 2014 and Lithuania in January 2015. All of the remaining new EU countries aspire to apply for Eurozone membership in the future.
Long-run convergence exists when the long-term forecasts of interest rates are equal and catching-up convergence is interpreted as the cointegration between the interest rates along a deterministic time trend.
Even though bond yields, in general, are driven by sovereign default risks, which are reflected in the sovereign credit ratings, 10-year bond yields can serve as indicators for the long-run perspectives of the respective economies. Thus, they can be used for examining monetary policy convergence between each new EU country and Germany.
If expected inflation differential converges to a small non-negative constant \(\pi_{0}\), the addition of a stationary ‘risk premium’ in Eq. (5) of the form \(u_{t} = \rho_{0} + \rho (L)u_{t - 1} + \nu_{t}\), where \(\rho (L)\) is a m-order polynomial in the lag operator \(L\) and \(\nu_{t}\) is a zero mean stochastic process, in order to reflect imperfect substitutability of bonds will still be consistent with the definition of weak convergence.
Perron (2006) provides a comprehensive review of this literature.
The current analysis can be extended by including both known and unknown break dates and implementing the cointegration methodology proposed by Carrion-i-Silvestre and Sansó (2006). But this is left for future research.
See also, Brunnermeier (2009).
The author is grateful to Carsten Trenkler for kindly providing him with the GAUSS codes.
One could attribute this evidence to the fact that Germany plays a major role in the economies of the Czech Republic, Lithuania and Slovakia. However, this argument does not necessarily imply that Germany is of less importance for the economies of the rest of the new EU countries, as, for example, for Poland.
Cyprus, Latvia, Malta and Slovenia joined the ERM II, Hungary pegged its currency to the euro, Poland implemented a free-floating exchange rate regime, while Bulgaria adopted a euro-based currency board.
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Acknowledgements
This study was funded by the Special Account for Research (ELKE – Project KA4449) of the University of Crete. I would like to thank two anonymous referees for their constructive comments that improved the quality of the paper. All the remaining errors are my own responsibility.
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Koukouritakis, M. Eurozone debt crisis and bond yields convergence: evidence from the new EU countries. Econ Change Restruct 50, 239–258 (2017). https://doi.org/10.1007/s10644-017-9208-3
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DOI: https://doi.org/10.1007/s10644-017-9208-3