The Marcoeconomic Effects of Oil Price, Credit Cycles, and the Sovereign Risk Premium

Sovereign credit risk in developed countries was essentially non-existent prior to 2009. We find new factors suggesting that a part of the European sovereign risk premium is exogenously determined. We capture a novel phase synchronization that is associated with an increase in the cost of public debt. We start by showing that macroeconomic effects of oil price shocks have changed over time, even though the magnitude of the shocks is similar across different episodes. To explain this change, we suggest that the magnitude of the effect is different in 2008 because there is “phase synchronization” where oil price and credit cycles are synchronized in an unprecedented boom and bust episode. To test this hypothesis, we propose a novel econometric procedure, by introducing a Markov-Switching VAR model, and matching it with estimated oil price episodes (Blanchard and Galí, 2009) and credit booms (Jordà, Schularick, and Taylor, 2013). Once we establish the relationship between the cycles and the macroeconomic aggregates, we estimate impulse response functions to find that only during the phase synchronization of the two cycles the magnitude of the effect is strong with a clear sign across the whole time period, affects macroeconomic dynamics and transmits to the sovereign credit market