Adjusting to reduced government securities in Australia and the Euro-Zone

The structure of fmancial markets in the USA, Euro-zone and Australia have undergone significant changes in response to the reduced need for their central banks to issue government securities. For example, the adoption of an Economic and Monetmy Union (EMU) has required a high degree of consistency in a number of policy areas including mles to restrict the size of budget deficits. ill the early 2000's adjusting to reduced government securities was a key consideration in US fmance literature (Reinha1t and Sack, 2000; Journal of Money, Credit and Banking, 2002, 2), but has become less important with the resurgence of large domestic deficit budgets in the US since 2002. The continued surplus budgets in Australia have meant that the implications of less government bonds outstanding on fmancial markets continues to be discussed. Most of the EMU countries have run moderate budget deficits (% GDP), so the absolute amount of euro-denominated government securities outstanding has fluctuated and tended to grow slowly. Therefore fear of a severe liquidity squeeze has not eventuated but some aspects of changed and restricted issuance have continued to be relevant. The Australian Treasurer adopted a medium term commitment to achieve and then maintain surplus budgets (from 1997), reducing the need for government bond issuance in the Australian fmancial market. In an Australian Government initiated Review on the Commonwealth Government Securities Market (Review) (2002), stakeholders views were sought on the extent to which government bonds offer unique financial market characteristics. The Review invited discussion of alternative · instruments to replace the dominant role of government securities. This research paper investigates developments in the Australian financial market since the Review (2002), and considers whether a rapid growth of corporate bonds has allowed adequate availability of low risk securities with benchmark status and liquidity, as existed in a government bond dominated fixed interest security market. The paper compares Australian experience with EMU markets, where growth of an interest rate swap market and credit derivatives have helped manage credit risk as well as supplement market liquidity. The research makes a preliminary assessment of how these financial markets have adapted to changed availability of government security issuance.