Size and liquidity of government bond markets

Robert McCauley and Eli Remolona

BIS Quarterly Review, 2000

Abstract: shrinking the fastest in absolute terms, fiscal surpluses in such countries as Australia and Sweden would on present trends eliminate their central government debt ahead of those in the United States (Graph IV.1). At the other end of the spectrum, Japan’s fiscal deficits are producing the world’s biggest government bond market, while those of France and Spain are serving to maintain the size of the euro-denominated market. At the same time, some emerging market countries are having to increase their public sector debt to finance the recapitalisation of distressed banking systems. As different as their fiscal circumstances may be, most governments have revealed a common interest in fostering market liquidity. In pursuing this goal, policymakers have regarded various dimensions of the size of the market as key considerations. In several industrial countries, where budget surpluses are shrinking debt, the authorities are trying to preserve liquidity by maintaining gross issuance in specific securities even as net issuance in all securities declines. The finance ministries in emerging market countries view growing debt as providing an opportunity to develop domestic bond markets – private as well as government – to reduce not only the cost of borrowing but also reliance on overseas financing in foreign currency. After briefly describing the emergence of liquidity in some markets, this article takes up the question of the critical size for a liquid market. It then discusses one way of creating size: through lumping together different types of debt. Next it characterises the trade-off between size and crowding-out. Finally, it raises some issues concerning the transition in growing and shrinking markets.

Date: 2000
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