VoxEU Column COVID-19 EU policies

Economic policy and financial market expectations during COVID-19

The ongoing COVID-19 pandemic in Europe is severe and spreads economic uncertainty. This column explores the evolution of financial market participants’ expectations during the COVID-19 pandemic, estimating yield curves of bonds in France, Germany, Italy, and Spain. The authors carry out an event study to investigate the potential impact of European fiscal and monetary policy measures on these yields. The results suggest that policy measures must be large and coordinated on the European level, and that fiscal and monetary policy must act jointly to fight the pandemic’s negative economic consequences

One thing is for certain: the ongoing COVID-19 pandemic in Europe is severe and spreads economic uncertainty. Policymakers and economists alike have understood the threat to the economic system and have worked collaboratively on appropriate strategies and policy measures to counteract the downturn. Many opinion pieces and policy recommendations have emerged to support the decision-making process of policymakers. These works span (among others) the field of monetary policy (Lane 2020), fiscal policy (Bénassy-Quéré et al. 2020), as well as their coordination (Barewell et al. 2020).

Our study continues along these lines and aims to contribute on the empirical side of the economic policy debate. A prerequisite for a successful and elaborate economic policy reaction is, and remains, a solid data basis. Our analysis helps support an understanding of what is currently going on in the economy by focusing on financial market participants’ expectations of the pandemic’s economic consequences. As the effectiveness of economic policies hinges crucially on expectations, our exercise is a necessary first step in the evaluation of policy measures.

To identify financial market participants’ expectations, we follow the method of McCulloch (1971, 1975), which was recently applied by Bayer et al. (2019), and estimate (non-parametrically) yield curves for a large sample of non-financial corporate bonds. We use data for bonds of different maturities found in France, Germany, Italy and Spain, between 01 January 2020 and 27 March 2020. This approach allows us to create a differentiated perspective on the topic. First, we can illustrate how financial market participants’ expectations towards the pandemic differ in the short- and long-run. Second, we can carry out an event study and relate the evolution of the yield curves during the pandemic to the most important monetary and fiscal policy measures taken implemented at the European and national level so far.

It is clear by now that COVID-19 is going to have long-lasting negative consequences on the economy. Policymakers must apply their measures optimally to counteract the downturn. They must ensure that their decisions are well-informed and based on thoroughly conducted empirical evaluations. The results of our study can provide useful clarity, putting the quickly prepared monetary and fiscal policy measures (taken in Europe between February and March 2020) in context, helping to draw lessons for the next decisions to come. In light of our findings, we propose that (i) the policy interventions undertaken so far seem to be going in the right direction, but do not yet suffice, and (ii) that this is especially true of the fiscal policy measures, which have to be larger in size. Finally, (iii) monetary and fiscal policy responses have to be coordinated on the European level, in order to be effective.

Financial market participants expect long-lasting negative economic consequences of COVID-19

As shown in Figure 1, non-financial corporations in each of four studied countries experienced a sudden and extreme increase in financial risk from the beginning of March 2020. This is particularly clear on 9 March 2020 (shown by the black vertical line in Figure 1), which coincides with the global stock market crash, the start of the lockdown in Italy (caused by the arrival of the COVID-19 pandemic in Europe), and accelerating yield increases. The impact is most noticeable in Italy, where the five-year yields almost tripled over the following days. Moreover, the pandemic seems to influence all maturities, especially in the long run. Since mid-March, the five-year maturities in all of the listed countries increased drastically, meaning that the pandemic’s negative economic consequences are currently still expected to be long lasting.

Figure 1 Yield curves of euro-area non-financial corporations with stock market crash and Italian lockdown on 9 March 2020 (black vertical line)

Fiscal and monetary interventions as stabiliser of expectations

To put the financial market participants’ expectations in context with the major fiscal and monetary policy interventions in the euro area taken so far, we conduct an event study. Because the yield curves with longer maturities experienced an especially drastic increase since the arrival of COVID-19 in Europe, the following exercise focuses exclu­sively on the five-year yield curves.

In terms of monetary policy, we look at the Pandemic Emergency Purchase Programme (PEPP), which was announced late in theevening of 18 March 2020. In terms of fiscal policy, we include the major rescue package for each country. France (€45 billion) and Spain (€200 billion) announced their rescue packages on 17 March, with Germany announcing its ‘bazooka’ (€550 billion) on 13 March, and Italy (€25 billion) having gone public on 10 March.

Figure 2 summarises the fiscal policy interventions. In general, fiscal policy interventions do not seem to coincide with a change in the five-year yields. Germany represents an exception, where the introduction of the ‘bazooka’ coincides with a temporary stabilisation of financial market participants’ expectations of the pandemic’s negative economic consequences. Interestingly, the German rescue package seems to temporarily stabilise the yields of France, Italy, and Spain as well.

Figure 3 stresses the development of the five-year yields with regard to the PEPP. Interestingly, the monetary policy intervention coincides with a drop in financial risk of comparable size in all four countries. 

Figure 2 Fiscal policy interventions in the euro area, five-year maturity

Figure 3 PEPP intervention by the ECB, five-year maturity

No halfway solutions - especially on the fiscal side

Since March 2020, financial market participants have expected the economic consequences of the COVID-19 pandemic to be severe and long-lasting. While the ECB’s policy measures have helped to stabilise financial market participants’ expectations, the fiscal policy measures taken so far on a national level still seem too timid. Only the announcement of the €550 billion rescue package in Germany coincides with a stabilisation of market expectations. A full causal evaluation of the economic policy measures taken as a response to COVID-19 so far is still needed. However, we can conclude from this event study that an adequate fiscal policy response must be well coordinated, with all European countries on board.


Bayer, C, C Kim, and A Kriwoluzky (2019), “The term structure of redenomination risk”.

McCulloch, J H (1971), “Measuring the term structure of interest rates”, The Journal of Business 44 (1): 19-31.

McCulloch, J H (1975), “The tax-adjusted yield curve”, The Journal of Finance 30 (3): 811-830

3,779 Reads