Governments’ supply response

Next, I examine governments’ response in their maturity choice of debt issues to the these changes in investor’s maturity-specific demand for peripheral and core Eurozone govern- ment debt following the announcement of the ECB’s three-year LTRO. As I will show below, peripheral governments accommodated peripheral banks “carry trade” demand for shorter debt maturities by reducing the supply of long-term debt. The corresponding gap- filling hypothesis is that core governments responded to this negative credit supply shock of long-term Eurozone government debt by filling the gap of longer maturity government debt.

In a first step, I analyze aggregate changes in the maturity structure of peripheral and core governments’ debt issues in response to the ECB’s three-year LTRO. Therefore, I compute the average maturity of all debt issues for both peripheral and core governments over time by weighting individual debt maturities by their notional issuance amount de- nominated in euro. Figure 2.5 shows that the average maturity of debt issues of peripheral and core governments shows a parallel trend before and after the LTRO-period, with core governments issuing debt with slightly shorter debt maturity compared to peripheral gov- ernments. However, during the LTRO-period the average maturity of debt issues diverged between peripheral and core governments. Consistent with peripheral governments accom- modating peripheral banks demand for “carry trades”, peripheral governments reduced their maturity of debt issues by 0.8 years to 2.6 years in the LTRO-period. Consistent with core governments’ gap-filling of longer maturity government debt, core governments increased their average maturity of debt issues by 2.2 years to 5.1 years in the LTRO- period.

This rotation of peripheral and core governments’ maturity structure of debt issues is also observed when analyzing the fraction of debt issues with maturities above three years over time (see Figure A. A.2.1 in the Appendix). Further and consistent my gap-filling results above, core governments decreased short-term (up to one year) debt issues to fill

the gap of longer maturity government debt (see Figure A. A.2.2 in the Appendix). In a second step, I investigate peripheral and core governments’ maturity choices follow- ing the ECB’s three-year LTRO in a regression setting. The baseline form of the regression I estimate is as follows:

ShareIssuei,m,t=β1·P eripherali·LT ROt+ β2·Corei·LT ROt

+ γ·Xi,m,t+ei,m,t ∀m∈M (2.2)

The dependent variable ShareIssuei,m,t is the share of debt issues of government i in quartert and maturity segmentm, which can either be up to three years or greater than three years. These two maturity buckets are aligned according to the maturity of the ECB’s three-year LTRO to reflect banks incentive to mitigate liquidity risk. The two key interaction terms in the regression are (P eripherali·LT ROt) and (Corei·LT ROt). P eripherali is an indicator variable equal to one if government i is a peripheral govern- ment, andCoreiis an indicator variable equal to one if governmentiis a core government. LT ROtis an indicator variable equal to one if quarter t falls into the LTRO-period from 2012:q1 to 2012:q3. To ensure that peripheral governments’ maturity choices are not af- fected by exclusion from capital markets and ongoing ESM-programs, I restrict peripheral governments to Italy and Spain. Core governments are Austria, Belgium, Finland, France, Germany, and the Netherlands, and the sample period is 2010:q1 to 2014:q3.21 I further

sequentially include different fixed effects, such as country, country-maturity, country- quarter, and maturity-quarter fixed effects. Standard errors are heteroscedasticity robust and clustered at the government level.

Table 2.7 reports the regression results. In all specifications, I find economically and at the 1%-level statistically significant coefficient estimates for changes of peripheral and core governments’ maturity choices during the LTRO-period. That is, consistent with accommodating peripheral banks “carry trade” demand, peripheral governments increased their share of debt issues up to three years by 19.9%-points in the LTRO-period (the average share of debt issues up to three years is 52.3% outside the LTRO-period) (see column (1)). Correspondingly, peripheral governments’ share of debt issues with maturities greater than three years reduced by 19.9% (see column (2)). Consistent with gap-filling, core governments increased their share of debt issues above three years by 14.5%-points in the LTRO-period (see column (2)). These maturity adjustments by core governments are equivalent to an increase of 44.8%, when compared to the mean share of debt issues greater than three years of 32.4%-points outside the LTRO-period. These regression results are also robust to sequentially including two-way fixed effects of country, maturity, and quarter.22 Overall, this event study shows that core governments’ gap-filling of longer 21_{This sample period is aligned to the gap-filling subperiod 2.4.2, but excludes periods affected by the}

introduction of the ECB’s Q.E. program. The results shown below are robust to extending the sample period until 2015:q3.

22

The results are also robust to analyzing governments’ debt maturity choice at a monthly, or yearly frequency, and aggregating debt issues at the government-level in the pre-LTRO- and LTRO-period as

maturity debt is a response to investor’s maturity-specific demand for government debt.