Business Case Studies & Business Publications

Draghi's Commitment

Warnock, Francis E...

Case

Draghi's Commitment

Warnock, Francis E.

GEM-0113 | Published August 8, 2013 | 26 pages Case

Collection: Darden School of Business

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Fully updated through end-2015, this case examines the eurozone from the perspective of core and periphery long-term rates. By 2010, the "Great Convergence" in eurozone long-term rates during the late 1990s had given way to the "Great Divergence" in which German long-term yields fell to record lows while Greek yields bounced between 20% and 40%. Periphery bond markets improved sharply in late summer 2012 after Draghi committed to do "whatever it takes" to preserve the euro. In 2015, some stresses were still evident, particularly in Greece, but in other periphery countries, the thinking was that Draghi's commitment to preserve the eurozone worked. The protagonist had two decisions to make. First, what was the path of core (i.e., German) eurozone long-term interest rates likely to be over the next year? Was the dramatic decline in German long rates over the past few years an aberration that would soon be reversed, or was it part of the "new normal" that would persist for some time? Second, how would periphery long rates evolve relative to core rates? That is?the spread between long rates in the likes of Greece, Ireland, Italy, Portugal, and Spain (GIIPS) and those in Germany?how would they evolve over the next year? Which was to be expected: another dramatic divergence in eurozone long rates, as eurozone politicians again disappointed, or a continuation of the impressive reconvergence that began in the second half of 2012? Was Draghi's commitment to preserve the euro enough or would the monetary union be torn apart by forces against which the central bank was powerless? This case is used in Darden's first- and second-year Global Financial Markets elective. It is appropriate for economics courses covering international and macro topics and for courses in international finance.