Analysis of the effect of the monetary policy response to COVID19 in Europe on the corporate bond market risk premium.

a) Draw the initial corporate bond market equilibrium, clearly labelled. Now the ECB in response to the COVID-19 shock has provided special loan facilities to corporations and ramped up its purchases of corporate bonds as part of its quantitative easing program. Will these measures increase or decrease default risk in the European corporate bond market? Why?

b) Demonstrate, using demand and/or supply curve shifts (if any) the effect of the policy on the market for corporate bonds, explaining your reasoning.

c) Illustrate the change in equilibrium in the government bond market equilibrium (if any) based on part (b), and the effect if any on the risk premium (credit spread) for corporate bonds in Europe, as a consequence of this ECB policy. Explain your reasoning.