The real effects of liquidity shocks in sovereign debt markets: evidence from Italy

Abstract

This paper provides the first empirical evidence on the macroeconomic effects of liquidity shocks in secondary sovereign debt markets. We consider the Italian case in a VAR analysis by applying different identification strategies: recursive ordering and Proxy-SVAR. Our findings suggest that liquidity is a major driver for indicators of economic activity. A shock to the Bid-Ask Spread induces a strong (15% of the Forecast Error Variance) and persistent (10 months) effect on unemployment and indicators of confidence. Liquidity shocks are transmitted to the real economy through changes in the lending behaviors of banks. On the one hand, an exogenous fall in liquidity induces/na tightening of banks standards, particularly due to the asset and liquidity position of commercial banks. On the other hand, firms report worse credit conditions in terms of higher costs apart from the interest rate. Similar macroeconomic implications hold for Spain, whereas liquidity shocks are not a significant driver for France and Germany.