Non‐residents’ Holdings, Market Volatility and Public Debt Sustainability. An Analysis with Data for Italy

Abstract

Non-residents' holdings (NRH) of debt securities have been large in euro area countries, but during the euro area debt crisis some of those countries experienced a steep contraction of such holdings. The analysis aims to provide a data-founded explanation of what is behind the decrease observed in 2011 by testing two alternative hypotheses. At the same time, we discuss how that decrease might have endangered the sustainability of public debt and study the empirical relevance of the most important of those processes. The topics presented refer to any advanced economy, but we check the hypotheses discussed by taking Italy as a case study because of data constraints. Italy is an interesting country to consider since it is a very large debt issuer. Our results point towards the importance of market volatility to explain variations of NRH, but those holdings do not seem to influence debt sustainability.Non-residents' holdings of public debt within the EA have been favored by the introduction of the common currency in 1999 (Lane, 2006), which boosted demand for NON-RESIDENTS' HOLDINGS AND PUBLIC DEBT 485

Market-Induced Fiscal Discipline in Europe

“…When interest rates increased because of rapidly deteriorating confidence (Cafiso 2016), the impact on the now larger amount of debt was unsustainable in the medium term. This motivated a reduction of public expenditure (the so-called austerity) in the effort to counterbalance the interest bill, to achieve a smaller deficit, and to show commitment to a sounder fiscal stance to financial markets.…”

“…The process leading to the Euro introduction has been characterized by decreasing interest rates on public debt in many Euro Area countries(Cafiso 2016); see Fig.4in the appendix.…”