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Size and liquidity of government bond markets
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LiquidityInternational Financial CrisisGlobal Liquidity RiskGovernment DebtMonetary PolicyInternational FinanceCentral Government DebtExternal DebtGlobal Financial MarketsPublic Sector DebtSovereign DebtEconomicsMarket LiquidityInternational Capital MarketLoansBond MarketFinanceFinancial EconomicsPublic FinanceMacroeconomicsEconomic StabilityBusinessInternational DebtCurrency CrisesGovernment Bond MarketsCapital StructureFinancial Crisis
Government bond markets differ markedly: while some industrial nations are shrinking debt, others like Japan maintain large deficits, and emerging economies are expanding debt to build domestic markets, yet all governments prioritize liquidity and view market size as a key determinant. The article examines what constitutes a critically liquid market size and discusses transition challenges in both expanding and contracting markets. It analyzes liquidity preservation through sustained gross issuance amid falling net issuance, size creation by aggregating diverse debt types, and the trade‑off between market size and crowding‑out.
shrinking the fastest in absolute terms, fiscal surpluses in such countries as Australia and Sweden would on present trends eliminate their central government debt ahead of those in the United States (Graph IV.1). At the other end of the spectrum, Japan’s fiscal deficits are producing the world’s biggest government bond market, while those of France and Spain are serving to maintain the size of the euro-denominated market. At the same time, some emerging market countries are having to increase their public sector debt to finance the recapitalisation of distressed banking systems. As different as their fiscal circumstances may be, most governments have revealed a common interest in fostering market liquidity. In pursuing this goal, policymakers have regarded various dimensions of the size of the market as key considerations. In several industrial countries, where budget surpluses are shrinking debt, the authorities are trying to preserve liquidity by maintaining gross issuance in specific securities even as net issuance in all securities declines. The finance ministries in emerging market countries view growing debt as providing an opportunity to develop domestic bond markets – private as well as government – to reduce not only the cost of borrowing but also reliance on overseas financing in foreign currency. After briefly describing the emergence of liquidity in some markets, this article takes up the question of the critical size for a liquid market. It then discusses one way of creating size: through lumping together different types of debt. Next it characterises the trade-off between size and crowding-out. Finally, it raises some issues concerning the transition in growing and shrinking markets.