nep-eec New Economics Papers
on European Economics
Issue of 2011‒11‒28
sixteen papers chosen by
Giuseppe Marotta
University of Modena and Reggio Emilia

  1. Restrictive Fiscal Policies in Europe: What are the Likely Effects? By C. KERDRAIN; V. LAPÈGUE
  2. Does the European Financial Stability Facility bail out sovereigns or banks? An event study By Horvath, Balint; Huizinga, Harry
  3. External asymmetries in the euro area and the role of foreign direct investment By Nicos Christodoulakis; Vassilis Sarantides
  4. Sovereign spreads in the Euro Area. Which prospects for a Eurobond? By Carlo Favero; Alessandro Missale
  5. European exchange rates volatility and its asymmetrical components during the financial crisis By Daniel Stavárek
  6. The Eurozone Crisis: Institutional Setting, Structural Vulnerability, and Policies By Bruno Dallago; Chiara Guglielmetti
  7. Financial stress and economic activity in Germany and the Euro Area By Björn van Roye
  8. A Tale of Five PIIGS: Soft Budget Constraints and the EMU Sovereign Debt Crises By Thushyanthan Baskaran; Zohal Hessami
  9. Rules-based economic governance in the European Union: A reappraisal of national fiscal rules By Benczes, Istvan
  10. The Greek Debt Crisis: Suggested Solutions and Reforms By Leo Michelis
  11. Niurong as the target for NGDP targeting: Mario Draghi's nightmare? By Belgodere, Antoine
  12. Welfare, Labor Supply and Heterogeneous Preferences: Evidence for Europe and the US By Bargain, Olivier; Decoster, André; Dolls, Mathias; Neumann, Dirk; Peichl, Andreas; Siegloch, Sebastian
  13. The Current Currency Situation By William R. Cline; John Williamson
  14. Taxing the financial sector in the European Union By Danuše Nerudová
  15. The New Version of the Model MZE, Macroeconometric Model for the Eurozone By M. BARLET; M.-É. CLERC; M. GARNERO; V. LAPÈGUE; V. MARCUS
  16. Conditions for turning the ex ante risk premium into an ex post redemption for EU government debt By Colignatus, Thomas

  1. By: C. KERDRAIN (Insee); V. LAPÈGUE (Insee)
    Abstract: In Europe, fiscal policy will be distinctly more restrictive from 2011 onwards. The fiscal consolidation efforts scheduled for 2011 represent 1.2 percentage points of GDP in the eurozone and 1.8 percentage points in the UK. Such adjustments hit short-term demand and depress activity by Keynesian effects. However, non-Keynesian mechanisms can attenuate them, not least through expectations and supply effects. The impact of fiscal consolidation is also related to the economic background: in line with the recent developments on sovereign bond markets, fiscal variables are found to have a significant impact on interest rate spreads on euro area public bonds. According to our main result, when debt exceeds 100 percentage points of GDP, the marginal effect on the spread of one additional point of debt would be about 7 to 8 basis points. Accordingly, fiscal consolidation is likely to weigh down on euro area sovereign risk premiums. In this light, the NiGEM international macroeconomic model is used to assess the GDP impact of European fiscal consolidation plans. Overall, euro area's GDP in 2011 is estimated to have been 0.6% lower than in a scenario without fiscal consolidation. This impact may however be an upper bound: these simulations do not take account of the possibility of a sudden increase of financial distress following a major loss of confidence in the sovereign bonds of some euro area countries.
    Keywords: Fiscal consolidation, sovereign risk spread, eurozone
    JEL: E6 H6
    Date: 2011
  2. By: Horvath, Balint; Huizinga, Harry
    Abstract: On May 9, 2010 euro zone countries announced the creation of the European Financial Stability Facility as a response to the sovereign debt crisis. This paper investigates the impact of this announcement on bank share prices, bank CDS spreads and sovereign CDS spreads. The main private beneficiaries were bank creditors, especially of banks heavily exposed to southern Europe and Ireland and located in countries characterized by weak public finances. Furthermore, countries with weak public finances and banking systems heavily exposed to southern Europe and Ireland benefited, as evidenced by lower sovereign CDS spreads. The combined gains of bank debt holders and shareholders exceed the increase in the value of their sovereign debt exposures, suggesting that banks saw their contingent claim on the financial safety net increase in value.
    Keywords: Bailout; Banking; CDS spreads; Sovereign debt
    JEL: G21 G28 H63
    Date: 2011–11
  3. By: Nicos Christodoulakis (Athens University of Economics and Business); Vassilis Sarantides (Athens University of Economics and Business)
    Abstract: A few years after the establishment of the European Economic and Monetary Union (EMU), large asymmetries emerged in the trade balances and the current accounts of the member-states. A divide seems to separate two groups in the euro area, one with the northern countries achieving external surpluses and the other including the southern countries with large external deficits. We argue that a crucial factor in shaping productivity, and consequently affecting competitiveness and the external position of the economy, is the size and composition of Foreign Direct Investment (FDI) and find that the northern countries received more total FDI than the southern group. Moreover, the southern countries attracted more investment in real estate rather than the productive sector. Focusing on ten euro area economies over the period 1980-2009, we establish a positive relationship between FDI flows and trade balances in the northern countries, in contrast to a negative one for the southern group. Using industry-level data, we also establish a positive (negative) long-run relationship between FDI in the manufacturing (non-manufacturing) sector and the trade balance for the northern (southern) countries.
    Keywords: Euro area; trade balance; Foreign Direct Investment (FDI)
    JEL: F15 F21
    Date: 2011–06
  4. By: Carlo Favero; Alessandro Missale
    Abstract: In this paper, we provide new evidence on the determinants of sovereign yield spreads and contagion effects in the euro area in order to evaluate the rationale for a common Eurobond jointly guaranteed by euro-area Member States. We find that default risk is the main driver of yield spreads, suggesting small gains from greater liquidity. Fiscal fundamentals matter in the pricing of default risk but only as they interact with other countries’ yield spreads; i.e. with the global risk that the market perceives. More important, the impact of this global risk variable is not constant over time, a clear sign of contagion driven by shifts in market sentiment. This evidence points to a discontinuity in the disciplinary role of financial markets. If markets can stay irrational longer than a country can stay solvent, then the role of yield spreads on national bonds as a fiscal discipline device is considerably weakened, and issuing Eurobonds can be economically justified.
    Date: 2011
  5. By: Daniel Stavárek (Silesian University, School of Business Administration)
    Abstract: Two forms of asymmetry in the exchange rate volatility are examined in this paper. We analyze four currencies of new EU member states, two currencies of non euro area old EU members, US dollar and Swiss franc against the euro during the period financial crisis. We apply a modified TARCH model on data grouped into four phases of the financial crises differing in intensity and market sentiment. The results suggest that the exchange rates usually shared a similar trend in volatility. The presence of asymmetric attributes of the exchange rate volatility was relatively common. Similar symptoms of asymmetry were registered mainly in the new EU member states and Sweden. Appreciation movements seem to have significantly different effects on volatility than the depreciation movements of equal size (first form of asymmetry) particularly during the phases of crisis initialization and culmination. By contrast, a significant impact of divergence from the target exchange rate on the volatility (second form of asymmetry) was revealed principally during the crisis stabilization.
    Keywords: exchange rate volatility, asymmetry, TARCH model, financial crisis
    JEL: F31
    Date: 2011–11
  6. By: Bruno Dallago; Chiara Guglielmetti
    Abstract: The unfolding of the crisis in the Eurozone can be explained by the interaction of institutional features and policy failures, and by their interconnection with real and financial imbalances. The crisis has shown that internal divergence in the EZ is based on important structural components which are unsustainable in the long run. Indeed, the crisis has magnified the gap between the vulnerable peripheral member countries and a more resilient core. The paper analyses those factors that opened the way to the diffusion of the financial and economic crisis in the Eurozone. It also discusses the structural consequences of these events and critically analyses the institutional and political reforms which the Eurozone is facing in order to enhance its capability to cope with external shocks.
    Keywords: Eurozone; European Union; European Monetary Union; euro; Common fiscal parameters; Real convergence; Productivity
    JEL: P16 O10 E60
    Date: 2011
  7. By: Björn van Roye
    Abstract: The financial crisis 2008-2009 and the European sovereign debt crisis have shown that stress on financial markets is important for analyzing and forecasting economic activity. Since financial stress is not directly observable but is presumably reflected in many financial market variables, it is useful to derive an indicator summarizing the stress component of these variables. Therefore, I derive a financial market stress indicator (FMSI) for Germany and the Euro Area using a dynamic approximate factor model. Subsequently, applying these indicators, I analyse the effects of financial stress on economic activity in a small Bayesian VAR model. An increase in financial stress leads to a significant dampening of GDP growth and the inflation rate. Additionally, there is a substantial and persistent decline in short-term nominal interest rates. I find that about fifteen percent of variation in real GDP growth can be accounted for variations in financial stress for Germany and about 30 percent in the Euro Area. I show that the inclusion of the indicator significantly improves out-of-sample forecasting accuracy for real GDP growth in Germany compared to a model without the indicator and other forecast benchmarks
    Keywords: Forecasting, Financial stress indicator, Financial Systems, Recessions, Slowdowns, Financial Crises
    JEL: E5 E6 F3 G2 G14
    Date: 2011–11
  8. By: Thushyanthan Baskaran (Department of Economics, University of Göttingen, Germany); Zohal Hessami (Department of Economics, University of Konstanz, Germany)
    Abstract: Why are so many EU countries currently in dire fiscal straits? A popular explanation is that monetary unification led to bailout expectations, which in turn resulted in soft budget constraints and over-borrowing. This paper investigates the validity of this explanation by studying the effects of the Maastricht treaty and the introduction of the Euro on public deficits. To identify the causal effects of these last two stages of EMU, we apply the difference- in-difference methodology to a dataset that covers 26 OECD countries (including all EU-15 countries) over the 1975-2009 period. The estimations suggest that the effect of the EMU on deficits is limited to the so-called PIIGS countries. The signing of the Maastricht treaty triggered a reduction of deficits in this group of countries. Once the Euro had been introduced, the PIIGS expanded their deficits – but only to pre Maastricht levels. In other words, the Euro led to soft budget constraints, and the PIIGS exploited these soft budget constraints to some extent (but not excessively). From a policy perspective, our findings favor reforms in the direction of administrative rather than fiscal centralization for the EU.
    Keywords: EMU, PIIGS, monetary union, budget deficits, soft budget constraints
    Date: 2011–11–13
  9. By: Benczes, Istvan
    Abstract: The economic and financial crisis of 2007/2009 has posed unexpected challenges on both the global and the regional level. Besides the US, the EU has been the most severely hit by the current economic crisis. The financial and banking crisis on the one hand and the sovereign debt crisis on the other hand have clearly shown that without a bold, constructive and systematic change of the economic governance structure of the Union, not just the sustainability of the monetary zone but also the viability of the whole European integration process can be seriously undermined. The current crisis is, however, only a symptom, which made all those contradictions overt that were already heavily embedded in the system. Right from the very beginning, the deficit and the debt rules of the Maastricht Treaty and the Stability and Growth Pact have proved to be controversial cornerstones in the fiscal governance framework of the European Economic and Monetary Union (EMU). Yet, member states of the EU (both within and outside of the EMU) have shown an immense interest in adopting numerical constraints on the domestic level without hesitation. The main argument for the introduction of national fiscal rules was mostly to strengthen the accountability and credibility of national fiscal policy-making. The paper, however, claims that a relatively large portion of national rules were adopted only after the start of deceleration of the debt-to-GDP ratios. Accordingly, national rules were hardly the sole triggering factors of maintaining fiscal discipline; rather, they served as the key elements of a comprehensive reform package of public budgeting. It can be safely argued, therefore, that countries decide to adopt fiscal rules because they want to explicitly signal their strong commitment to fiscal discipline. In other words, it is not fiscal rules per se what matter in delivering fiscal stability but a strong political commitment.
    Keywords: fiscal governance; fiscal consolidation; fiscal rules; European Union
    JEL: E62 H50 H60
    Date: 2011–07–05
  10. By: Leo Michelis (Ryerson University; The Rimini Centre for Economic Analysis (RCEA))
    Abstract: This paper examines eight suggested solutions to the Greek debt crisis and six political and institutional reforms in order to achieve a single objective: eliminate deviations from the EU benchmark and thus transform the country into a modern EU state. In the absence of a national political consensus to tackle the debt crisis and implement political and institutional reforms, a new political force should be formed to accomplish these tasks, and also embrace the "frustrated" or "Facebook" generation’s demands for better living standards and more equitable income distribution.
    Keywords: Debt crisis, bank runs, euro zone, economic reforms, political reforms
    JEL: H63 G21 E44 F15 P48
    Date: 2011–11
  11. By: Belgodere, Antoine
    Abstract: NGDP targeting is presented by some macroeconomists as a good practice for central banks. But what should be the target value? I propose a relevant measure: the Non Increasing Unemployment Rate Of Nominal Growth (NIURONG). I use NIURONG to show how difficult would have been for European Central Bank to implement a relevant monetary policy for each Euro Area country in front of post-2008 economic downturn.
    Keywords: NDGP targeting; monetary policy; Optimal Currency Areas
    JEL: E58
    Date: 2011–11–20
  12. By: Bargain, Olivier (University of Aix-Marseille II); Decoster, André (K.U.Leuven); Dolls, Mathias (IZA); Neumann, Dirk (IZA); Peichl, Andreas (IZA); Siegloch, Sebastian (IZA)
    Abstract: Following the report of the Stiglitz Commission, measuring and comparing well-being across countries has gained renewed interest. Yet, analyses that go beyond income and incorporate non-market dimensions of welfare most often rely on the assumption of identical preferences to avoid the difficulties related to interpersonal comparisons. In this paper, we suggest an international comparison based on individual welfare rankings that fully retain preference heterogeneity. Focusing on the consumption-leisure trade-off, we estimate discrete choice labor supply models using harmonized microdata for 11 European countries and the US. We retrieve preference heterogeneity within and across countries and analyze several welfare criteria which take into account that differences in income are partly due to differences in tastes. The resulting welfare rankings clearly depend on the normative treatment of preference heterogeneity with alternative metrics. We show that these differences can indeed be explained by estimated preference heterogeneity across countries – rather than demographic composition.
    Keywords: welfare measures, preference heterogeneity, labor supply, Beyond GDP
    JEL: C35 D63 H24 H31 J22
    Date: 2011–11
  13. By: William R. Cline (Peterson Institute for International Economics); John Williamson (Peterson Institute for International Economics)
    Abstract: The currency markets have been extremely disturbed for the last three months. The period witnessed a major strengthening of the US dollar in September, then the European currency crisis, a recovery of the euro when the markets believed that the crisis was being controlled, and then a rebound of the dollar. In view of these developments, those who follow currency movements need a new guide as to how the current values of currencies compare to our estimates of fundamental equilibrium exchange rates (FEERs). The first section is devoted to a brief exposition of the main changes that have occurred since April, which our previous publication used as the benchmark. The second section updates information on the levels of effective exchange rates consistent with the FEER targets identified in our most recent estimates (Cline and Williamson 2011), as well as the FEER-consistent dollar rates as of late October. The third section steps outside our normal frame of reference in order to make some comments about the situation within Europe in view of the sovereign debt crisis currently raging there.
    Date: 2011–11
  14. By: Danuše Nerudová (Department of Accounting and Taxes, FBE MENDELU in Brno)
    Abstract: The recent financial crises has revealed the need to improve and ensure the stability of the financial sector to reduce negative externalities, to ensure fair and substantial contribution of the financial sector to the public finances and the need to consolidate public finance. The aim of the paper is to discuss the possibility of the financial sector taxation and to suggest the possible candidate suitable for the implementation on the EU level. Financial transaction tax represents the tool suitable mainly on global level, for only in that case enables to generate sufficient financial resources. From EU point of view is considered as less suitable, for it bears the risk of reallocation. Therefore the introduction of financial activities tax on EU level is considered as a better solution for the financial sector taxation in the EU, for financial sector is exempted from value added tax. However, the approval of directive in the area of taxation requires unanimity of all EU member states, which means that final solution will be also political question.
    Keywords: financial transaction tax, financial activities tax, tax base, crises, financial sector
    JEL: H25
    Date: 2011–11
  15. By: M. BARLET (Drees); M.-É. CLERC (Insee); M. GARNERO (Drees); V. LAPÈGUE (Insee); V. MARCUS (SGDD)
    Abstract: This paper presents the main improvements carried out to the macroeconometric model MZE since its creation in 2003. We have back-calculated the series over the period 1980-1995, in order to make the model more stable. To our knowledge, this paper is the first application of Kllians (1998) method to estimate coefficients and centered confidence intervals for an operational macroeconometric model. The new coefficients enable to get less inflationary responses to macroeconomic shocks than the previous version of MZE. The study is more nuanced and rigorous thanks to the confidence intervals around the main scenarios. It is thus possible to check the significance of the results at any horizon. At last, the new version of MZE enables to find conventional responses to international shocks, like the inflationary effect of a rise in oil prices or the delayed impact of a depreciation of the euro on the improvement of the trade balance.
    Keywords: Macroeconometric modelling, Forecasting, Confidence interval, Bootstrap
    JEL: C3 C5 E1 E2
    Date: 2011
  16. By: Colignatus, Thomas
    Abstract: Basel III classifies government debt as risk free while actual interest rates in the European Union (EU) show large differences not only because of liquidity but mainly because of the risk of default, as also reflected in credit default swaps. Curiously such debt defaults may not happen so that creditors do not need to cover losses. The risk premium then becomes a reward for taking a risk that does not materialize. Contagious fears create risk premia that destabilize government debts and national economies. A solution is to regard the risk premia as potential redemption that turns into actual redemption when the loan is served to maturity. A EU law may make this mandatory without serious restrictions to the credit market. The rule would be that governments under threat of default would issue only annuity loans with a centrally determined rate of interest. The market sentiment of increased risk then shows up in shorter maturities. Governments that can borrow only at shorter maturities but at higher annual liquidity requirements meet with strong incentives to better manage their economies. The paper investigates the conditions involved. An important distinction appears to exists between the risk free rate, the credit default risk premium, the liquidity premium and a stigma factor. While much of the debate in the EU seems to be about reducing the risk premium, the distinction between ex ante risk and ex post redemption allows to identify that true EU policy costs concern irrational stigma factors. Notably, aversion against Southern European debt, that differs from the risk free rate and the risk and liquidity premiums, has no rational base but can persist because it is rewarded.
    Keywords: Keywords: Economic stability; monetary policy; credit crunch; European Central Bank; CAPM; risk free rate; risk premium; liquidity premium; stigma effect;
    JEL: E00 A10 P16
    Date: 2011–11–17

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