The Sovereign-Bank Feedback Loop: Did European Policies Alleviate It?

Abstract

The outburst of the euro area sovereign debt crisis made evident the feedback loop between the sovereigns and the banks. The aim of this paper is to analyze whether the feedback loop has receded after the implementation by the European authorities of a number of monetary and regulatory policy measures. Our econometric exercises focus on the short and long-term dimensions of the feedback loop. Results reveal, for peripheral countries, a moderate decrease in the short-run feedback loop and a more pronounced decline of the long-run feedback counterpart. Despite this two-fold reduction in the feedback loop, our analysis shows that it has not disappeared. This calls for the need to adopt a number of additional policy and private sector measures.