Bank for International Settlements working paper finds public debt level and maturity shape monetary policy transmission across Europe

The Bank for International Settlements has published a working paper examining how the size and maturity profile of public debt affect the transmission of euro area monetary policy. The paper finds that higher public debt is associated with a weaker response of prices and inflation expectations to tighter monetary policy, while output falls at least as much as in lower-debt economies. It also finds that debt maturity matters in a non-linear way, with debt at intermediate maturities linked to weaker output and price effects, and debt at very short and long maturities linked to stronger effects. Using high-frequency euro area monetary policy shocks and panel local projections for 2001-2020, the paper argues that these patterns are consistent with the interaction of fiscal risk repricing, valuation effects and interest income effects. Fiscal responses point to a lack of contemporaneous fiscal backing, as primary balances tend to deteriorate and public debt rises relative to gross domestic product following monetary tightening, while expected long-term sovereign yields increase and expected bond returns fall. For advanced and emerging European economies outside the euro area, the paper introduces a new dataset on public debt maturity profiles and finds that euro area monetary tightening has contractionary spillovers on output and prices, with the strength of those spillovers depending on the receiving economy’s debt maturity structure and appearing strongest when more debt matures between four and eight years.