The Pass-Through of Sovereign Risk
Luigi Bocola ()
No 722, Working Papers from Federal Reserve Bank of Minneapolis
This paper examines the macroeconomic implications of sovereign credit risk in a business cycle model where banks are exposed to domestic government debt. The news of a future sovereign default hampers financial intermediation. First, it tightens the funding constraints of banks, reducing their available resources to finance firms (liquidity channel). Second, it generates a precautionary motive for banks to deleverage (risk channel). I estimate the model using Italian data, finding that i) sovereign credit risk was recessionary and that ii) the risk channel was sizable. I then use the model to evaluate the effects of subsidized long term loans to banks, calibrated to the ECB’s longer-term refinancing operations. The presence of strong precautionary motives at the time of policy enactment implies that bank lending to firms is not very sensitive to these credit market interventions.
Keywords: Sovereign debt crises; Financial constraints; Risk; Credit policies (search for similar items in EconPapers)
JEL-codes: E32 E44 G01 G21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-eec and nep-mac
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Journal Article: The Pass-Through of Sovereign Risk (2016)
Working Paper: The Pass-Through of Sovereign Risk (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedmwp:722
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