Would an earlier inception of OMT by the ECB have prevented the 2012 Greek default?

Abstract

To avert further debt crises following the Greek default of 2012, the European Central Bank (ECB) adopted outright purchases of sovereign bonds as part of its monetary policy regime. This paper examines whether an earlier inception of such purchases (OMT) could have prevented the observed Greek repudiation. To account for the extraordinary circumstances surrounding the Greek default, I construct a novel model of sovereign finance in which default is political and investors’ reliance on external credit ratings gives rise to slow moving crises. Estimating the model with Greek data, I find that an earlier inception of OMT plausibly could have prevented the observed default, but the resulting counterfactual Greek state would have been so fragile that, absent any further fiscal consolidation, eventual default was effectively inevitable. Moreover, the present Greek state remains sufficiently fragile that a quick return to a predominantly private financing scheme is not advisable.