Effects of a sovereign credit rating upgrade to investment grade on the Greek economy

The paper investigates the potential effects of a sovereign credit rating upgrade to investment grade on the trajectory of the Greek economy. A cross-country empirical analysis of past upgrades suggests that an economy’s upgrade to investment grade is associated with a reduction in sovereign bond yields and spreads by about 70 basis points. In the long run, such an upgrade boosts real GDP and reduces GDP volatility by 2.5% and 0.48%, respectively. Furthermore, the findings derived from a dynamic factor model indicate that an upgrade to investment grade is expected to reduce Greek sovereign bond yields and pass through to the Greek banking sector by reducing its funding costs and narrowing the spread between Greek and euro area bank bonds. Subsequently, a DSGE model featuring a rich financial sector, calibrated to the Greek economy, is employed to trace the dynamic responses of key financial and real variables to an upgrade to investment grade. The model suggests that an upgrade to investment grade that reduces bank funding costs has a positive impact on the real and financial sectors of the Greek economy in both the short and the long run. Finally, counterfactual experiments illustrate that a sovereign credit rating upgrade to investment grade has a stabilising effect on both the banking sector and the real economy in the face of adverse shocks.