We analyze determinants of sovereign bond yields in 22 advanced economies over the 1980-2010 period using panel cointegration techniques. The application of cointegration methodology allows distinguishing between long-run (debt-to-GDP ratio, potential growth) and short-run (inflation, short-term interest rates, etc.) determinants of sovereign borrowing costs. We find that in the long-run, government bond yields increase by about 2 basis points in response to a 1 percentage point increase in government debt-to-GDP ratio and by about 45 basis points in response to a 1 percentage point increase in potential growth rate. In the short-run, sovereign bond yields deviate from the level determined by the long-run fundamentals, but about half of the deviation adjusts in one year. When considering the impact of the global financial crisis on sovereign borrowing costs in euro area countries, the estimations suggest that spreads against Germany in some European periphery countries exceeded the level determined by fundamentals in the aftermath of the crisis, while some North European countries have benefited from “safe haven” flows.
other markets, this provides an important economic link between countries.
2. The paper examines these links using data from inflation-indexed bonds . One limitation with previous work has been the difficulty in separating realbondyields from long-term inflation expectations. Fortunately, this decomposition has been facilitated by the development of inflation-indexed bonds, which allow these two components of nominal yields to be continuously tracked. With the U.S. inflation-indexed bond market now almost a decade old, there is sufficient information to allow
This paper explores international bond spillovers using daily and intra-day data on yields on inflation-indexed bonds and associated inflation expectations for the United States, Australia, Canada, France, Sweden, Japan, and the United Kingdom. The analysis starts in 2002, by which point U.S. inflation-indexed markets were fully mature. Real bond yields are found to be closely linked across countries, with developments in U.S. markets determining around half of real foreign yields and no evidence of spillovers back to the United States. Spillovers in inflation expectations are smaller and the direction of causation is less clear.
considered to have a larger impact on activity than the short-term rates that monetary authorities target, globalized markets in government securities provide an important economic as well as financial link between countries.
In the past, one limitation in analyzing these links has been that it is difficult to separate realbondyields, which would be expected to be highly linked across countries, from changes in long-term inflation expectations, which would be heavily influenced by domestic monetary policy. Fortunately, the decomposition of nominal yields into these two
are generally considered to have a larger impact on activity than the short-term rates that monetary authorities target, this provides an important economic link between countries.
In the past, one limitation in analyzing these links has been that it is difficult to separate realbondyields, which would be expected to be highly linked across countries, from changes in long-term inflation expectations. Fortunately, this decomposition has been greatly assisted by the development of inflation-indexed bonds, which allow prices of these two components of bond yields
A. Theoretical Considerations
Economic theory suggests that in the long-run real government bond yields depend on two main determinants: potential output growth and government debt.
The link between potential output growth and realbondyield can be illustrated using the Euler’s equation from the consumer’s utility maximization problem. In a Ramsey model of economic growth with a representative household preferences described by the CES utility function and production process described by the Cobb-Douglas function, the deterministic steady state of