Timing Does Matter: Institutional Flaws and the European Debt Crisis

Financial crises are complex phenomena. Yet, at the cost of some simplifications, the literature has identified two main elements causing the crises: macroeconomic imbalances and institutional design flaws. Economists recognise that both play some role, but disagree on their strength. Using Bai and Perron's technique and an EGARCH model we contribute to the debate on the European debt crisis by identifying break dates and changes in volatility in daily values of 10-year public bond interest rates for Greece, Italy and Spain. The results are then related to key political and institutional events. The results of our econometric exercise uncover the following facts: the crisis began in May 2010; worsened after summer 2011, as the European authorities hastened to restructure the Greek debt; improved during summer 2012, when the ECB approved the OMTs, a new programme for the purchase of bonds. On the whole, the results are compatible with an interpretation of the crisis that considers the institutional flaws as the main cause.