Why Italian bonds remain riskier compared to Japanese despite latter having higher government debt?

The praise or blame as expected is on central bank doors.

Prof. Athanasios Orphanides who is also former head of Bank of Cyprus blames ECB for Italy’s woes:

For Japan, the dramatic rise of the debt ratio before the crisis reflects the lack of nominal growth.  While the long-term government bond yield appeared to be low (consistently below 2%), nominal GDP growth was even lower (about zero, on average). The adverse debt dynamics worsened after 2007, with the recession following the Global Crisis. Part of the problem was overly tight monetary policy: policy rates were constrained by the zero lower bound (ZLB), but the Bank of Japan was reluctant to employ the required QE policies. However, since 2013 the Bank of Japan has embarked on a decisive QE programme which has simultaneously boosted nominal GDP growth and depressed long-term government bond yields. Since September 2016, as part of its ‘Quantitative and Qualitative Monetary Easing with Yield Curve Control’ policy, the Bank of Japan has communicated explicitly its intention to keep the 10-year yield on government bonds close to zero and short-term interest rates negative until inflation rises to 2%, in line with its definition of price stability. This monetary policy has stabilised Japan’s debt dynamics and has provided the Japanese government more time to implement structural reform measures and complete the fiscal adjustment needed to bring its primary deficit under control.

In contrast to Japan, where in the past few years decisive monetary policy actions have allayed fiscal concerns, in Italy monetary policy decisions appear to have contributed to debt sustainability concerns. Italy shares its central bank, the ECB, with other Eurozone member states, including Germany. The ECB is obligated to implement a single monetary policy for the benefit of the Eurozone as a whole. However, since the crisis, the ECB has adopted policies with decidedly uneven economic consequences for Eurozone member states.  Italian nominal GDP growth has been consistently and significantly below Germany’s, while the long-term yield on Italian government debt has been consistently and significantly above Germany’s. While some of the difference can be attributed to non-monetary factors, discretionary ECB decisions have played a critical role. Among others, the single monetary policy in the Eurozone has been implemented in a manner that has tended to reinforce tighter monetary conditions in Italy than in Germany, contributing to a deep and prolonged recession in Italy while facilitating faster growth in Germany.  

Monetary policy and fiscal dynamics are inexorably linked. Without compromising price stability, central banks in advanced countries have the power to pursue policies that can allay debt sustainability concerns. Comparing Japan and Italy, against the backdrop of Germany, is instructive for understanding this power and its consequences.

A beaten tale really. I mean on one hand we are told central bank should not engage in fiscal policy but on the other they are criticised for not doing enough. Either ways you are doomed.


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