Sovereign spreads and unconventional monetary policy in the Euro area: A tale of three shocks

High-frequency (HF) monetary surprises around central bank meetings are extensively employed to jointly identify monetary policy shocks and the so-called ‘information shock’. In this paper we show that HF surprises in the Euro Area after 2008 reflect the impact of three shocks, not two. Besides an unconventional monetary shock and the information shock, we consider a third shock, labeled ‘spread shock’, resulting from the ECB management of fragmentation risk in the sovereign bond market. The spread shock can be framed within a stylized model of multiple equilibria where a central bank in a monetary union attempts to offset self-fulling expectations of default in sovereign debts. We point-identify simultaneously the dynamic causal effects produced by the three monetary policy shocks by using a proxy-SVAR estimated on daily data. The external instruments are obtained from HF monetary surprises combining sign and narrative restrictions, and additional point restrictions are exploited for the identification in a second stage. Empirical results based on Italian (Spanish) spreads, reveal that the spread shock represents an important ingredient of the transmission mechanism of monetary policy in the Euro Area after the Global Financial Crisis. Identification-robust confidence intervals show that the impact of the spread shock on monthly variables like industrial production and measures of systemic risk and financial distress is non-negligible and aligns with the idea that the ECB stabilizes fragmentation risk.