nep-eec New Economics Papers
on European Economics
Issue of 2011‒12‒13
twenty papers chosen by
Giuseppe Marotta
University of Modena and Reggio Emilia

  1. The Euro and European Economic Conditions By Martin S. Feldstein
  2. Risk Sharing through Capital Gains By Faruk Balli; Sebnem Kalemli-Ozcan; Bent Sorensen
  3. Credit and liquidity risks in euro area sovereign yield curves By Monfort, A.; Renne, J-P.
  4. Fiscal Policy, Eurobonds and Economic Recovery: Some Heterodox Policy Recipes against Financial Instability and Sovereign Debt Crisis By Alberto Botta
  5. Target Loans, Current Account Balances and Capital Flows: The ECB’s Rescue Facility By Hans-Werner Sinn; Timo Wollmershaeuser
  6. Volatility, Money Market Rates, and the Transmission of Monetary Policy By Seth B. Carpenter; Selva Demiralp
  7. Emigration and Wages: The EU Enlargement Experiment By Elsner, Benjamin
  8. Monetary transmission right from the start: On the information content of the eurosystem's main refinancing operations By Abbassi, Puriya; Nautz, Dieter
  9. A Pyrrhic Victory? Bank Bailouts and Sovereign Credit Risk By Acharya, Viral V.; Drechsler, Itamar; Schnabl, Philipp
  10. Culture Matters: French-German Conflicts on European Central Bank Independence By Femke van Esch; Eelke de Jong
  11. Macroeconomic effects of unconventional monetary policy in the Euro area By Gert Peersman
  12. The Irish Macroeconomic Response to an External Shock with an Application to Stress Testing By Birmingham, Colin; Conefrey, Thomas
  13. Apocalypse Then: The Evolution of the North Atlantic Economy and the Global Crisis By Bayoumi, Tamim; Bui, Trung
  14. Getting Back on Track: Restoring Fiscal Sustainability in Ireland By David Haugh
  15. Does the EU financing system contribute to shadow economic activity? By Theilen, Bernd, 1965-; Herwartz, Helmut
  16. The Dynamics of Deposit Euroization in European Post-transition Countries: Evidence from Threshold VAR By Marina Tkalec
  17. Labor Productivity and Vocational Training: Evidence from Europe By Sala, Hector; Silva, José I.
  18. Does TFP drive housing prices? a growth accounting exercise for four countries By Alessio Moro; Galo Nuño
  19. Welfare Participation by Immigrants in the UK By Drinkwater, Stephen; Robinson, Catherine
  20. On price convergence in Eurozone By David Guerreiro; Valérie Mignon

  1. By: Martin S. Feldstein
    Abstract: The creation of the euro should now be recognized as an experiment that has led to the sovereign debt crisis in several countries, the fragile condition of major European banks, the high levels of unemployment, and the large trade deficits that now exist in most Eurozone countries. Although the European Central Bank managed the euro in a way that achieved a low rate of inflation, other countries both in Europe and elsewhere have also had a decade of low inflation without incurring the costs of a monetary union. The emergence of these problems just a dozen years after the start of the euro in 1999 was not an accident or the result of bureaucratic mismanagement but the inevitable consequence of imposing a single currency on a very heterogeneous group of countries, a heterogeneity that includes not only economic structures but also fiscal traditions and social attitudes. This paper reviews (1) the reasons for these economic problems, (2) the political origins of the European Monetary Union, (3) the current attempts to solve the sovereign debt problem, (4) the long-term problem of inter-country differences of productivity growth and competitiveness, (5) the special problems of Greece and Italy, (6) and the pros and cons of a Greek departure from the Eurozone.
    JEL: E0
    Date: 2011–11
  2. By: Faruk Balli; Sebnem Kalemli-Ozcan; Bent Sorensen
    Abstract: We estimate channels of international risk sharing between European Monetary Union (EMU), European Union, and other OECD countries 1992-2007. We focus on risk sharing through savings, factor income flows, and capital gains. Risk sharing through factor income and capital gains was close to zero before 1999 but has increased since then. Risk sharing from capital gains, at about 6 percent, is higher than risk sharing from factor income flows for European Union countries and OECD countries. Risk sharing from factor income flows is higher for Euro zone countries, at 14 percent, reflecting increased international asset and liability holdings in the Euro area.
    JEL: F21 F36
    Date: 2011–11
  3. By: Monfort, A.; Renne, J-P.
    Abstract: In this paper, we propose a model of the joint dynamics of euro-area sovereign yield curves. The arbitrage-free valuation framework involves five factors and two regimes, one of the latter being interpreted as a crisis regime. These common factors and regimes explain most of the fluctuations in euro-area yields and spreads. The regime-switching feature of the model turns out to be particularly relevant to capture the rise in volatility experienced by fixed-income markets over the last years. In our reduced-form set up, each country is characterized by a hazard rate, specified as some linear combinations of the factors and regimes. The hazard rates incorporate both liquidity and credit components, that we aim at disentangling. The estimation suggests that a substantial share of the changes in euro-area yield differentials is liquidity-driven. Our approach is consistent with the fact that sovereign default risk is not diversifiable, which gives rise to specific risk premia that are incorporated in spreads. Once liquidity-pricing effects and risk premia are filtered out of the spreads, we obtain estimates of the actual –or real-world– default probabilities. The latter turn out to be significantly lower than their risk-neutral counterparts.
    Keywords: default risk, liquidity risk, term structure of interest rates, regime-switching, euro-area spreads.
    JEL: E43 E44 E47 G12 G24
    Date: 2011
  4. By: Alberto Botta (Department of Economics, University of Insubria, Italy)
    Abstract: In this paper, we propose a simple post-Keynesian model on the linkages between the financial and real side of an economy. We show how, according to the Minskyan instability hypothesis, financial variables, credit availability and asset prices in particular, may feedback each other and affect economic activity, possibly giving rise to intrinsically unstable economic processes. Through these destabilizing mechanisms, we also explain why governments intervention in the aftermath of the 2007 financial meltdown has been largely useless to restore financial tranquility and economic growth, but transformed a private debt crisis into a sovereign debt one. The paper ends up by looking at the long run and to the interaction between long-term growth potential and public debt sustainability. We explicitly consider the European economic context and the difficulties several EU members currently face to simultaneously support economic recovery and consolidate fiscal imbalances. We stress that: (i) financial turbulences may trigger permanent reductions in long-term growth potential and unsustainable public debt dynamics; (ii) strong institutional discontinuity such as EU financial assistance to member countries may prove to be the only way to restore growth and ensure long-run public debt sustainability.
    Keywords: post-Keynesian models, financial instability, debt sustainability, Eurobonds JEL Classification: E12, E44, H63
    Date: 2011–12
  5. By: Hans-Werner Sinn; Timo Wollmershaeuser
    Abstract: The European Monetary Union is stuck in a severe balance-of-payments imbalance of a nature similar to the one that destroyed the Bretton Woods System. Greece, Ireland, Portugal, Spain and Italy have suffered from balance-of-payments deficits whose accumulated value, as measured by the Target balances in the national central banks’ balance sheets, was 404 billion euros in August 2011. The national central banks of these countries covered the deficits by creating and lending out additional central bank money that flowed to the euro core countries, Germany in particular, and crowded out the central bank money resulting from local refinancing operations. Thus the ECB forced a public capital export from the core countries that partly compensated for the now reluctant private capital flows to, and the capital flight from, the periphery countries.
    JEL: E50 E58 E63 F32 F34
    Date: 2011–11
  6. By: Seth B. Carpenter (Division of Monetary Affairs Board of Governors of the Federal Reserve System); Selva Demiralp (Koc University)
    Abstract: We explore the effect of volatility in the federal funds market on the expectations hypothesis in money markets. We find that lower volatility in the bank funding markets market, all else equal, leads to a lower term premium and thus longer-term rates for a given setting of the overnight rate. The results appear to hold for the US as well as the Euro Area and the UK. The results have implications for the design of operational frameworks for the implementation of monetary policy and for the interpretation of the changes in the Libor-OIS spread during the financial crisis
    Keywords: Monetary transmission mechanism, expectations hypothesis, term premium
    JEL: E43 E52 E58
    Date: 2011–10
  7. By: Elsner, Benjamin (Trinity College Dublin)
    Abstract: The enlargement of the European Union provides a unique opportunity to study the impact of the lifting of migration restrictions on the migrant sending countries. With EU enlargement in 2004, 1.2 million workers from Eastern Europe emigrated to the UK and Ireland. I use this emigration wave to show that emigration significantly changed the wage distribution in the sending country, in particular between young and old workers. Using a novel dataset from Lithuania, the UK and Ireland for the calibration of a structural model of labor demand, I find that over the period of five years emigration increased the wages of young workers by 6%, while it had no effect on the wages of old workers. Contrary to the immigration literature, there is no significant effect of emigration on the wage distribution between high-skilled and low-skilled workers.
    Keywords: emigration, EU enlargement, European integration, wage distribution
    JEL: F22 J31 O15 R23
    Date: 2011–11
  8. By: Abbassi, Puriya; Nautz, Dieter
    Abstract: The Eurosystem's main refinancing operations (MRO) are key for the interbank money market and the monetary transmission process in the euro area. This paper investigates how money market rates respond to the information revealed by various aspects of an MRO auction outcome. Our results confirm that the level of MRO rates governed short-term money market rates before the financial crisis. Since the start of the financial crisis, however, the information content of MRO rates has changed. While the levels of MRO rates have lost much of their pre-crisis significance, the spread between the weighted average and the marginal MRO rate has become an important barometer for the actual situation in the money market during the crisis. --
    Keywords: monetary policy implementation,central bank auctions,European Central Bank,money markets and financial crisis
    JEL: E43 E52 E58 D44
    Date: 2011
  9. By: Acharya, Viral V.; Drechsler, Itamar; Schnabl, Philipp
    Abstract: We show that financial sector bailouts and sovereign credit risk are intimately linked. A bailout benefits the economy by ameliorating the under-investment problem of the financial sector. However, increasing taxation of the non-financial sector to fund the bailout may be inefficient since it weakens its incentive to invest, decreasing growth. Instead, the sovereign may choose to fund the bailout by diluting existing government bondholders, resulting in a deterioration of the sovereign's creditworthiness. This deterioration feeds back to the financial sector, reducing the value of its guarantees and existing bond holdings as well as increasing its sensitivity to future sovereign shocks. We provide empirical evidence for this two-way feedback between financial and sovereign credit risk using data on the credit default swaps (CDS) of the Eurozone countries and their banks for 2007-11. We show that the announcement of financial sector bailouts was associated with an immediate, unprecedented widening of sovereign CDS spreads and narrowing of bank CDS spreads; however, post-bailouts there emerged a significant co-movement between bank CDS and sovereign CDS, even after controlling for banks' equity performance, the latter being consistent with an effect of the quality of sovereign guarantees on bank credit risk.
    Keywords: credit default swaps; deleveraging; financial crises; forbearance; growth; sovereign debt
    JEL: D62 E58 G21 G28 G38
    Date: 2011–12
  10. By: Femke van Esch; Eelke de Jong
    Abstract: With the Maastricht treaty, the members of the Eurozone agreed on the establishment of a very independent European Central Bank, as well as making their National Central Banks far more independent. However, over the years French political leaders systematically brought forward proposals undermining the ECB's independence, to the dismay of Germany. A pattern that surfaced again during the current sovereign debt crisis and has complicated finding a timely and unified answer to the problems. The article conducts tests of various factors expected to influence the preference for central bank independence. It shows that economic explanations are unable to account for the persistent differences amongst European member-states on this issue. Instead, cultural differences in attitudes, especially a nation's score on the dimension of Power Distance - its acceptance of centralisation of power in a small set of political leaders or institutions - does show a correlation with the different levels of internalisation of the Central Bank independence norm.
    Keywords: Central Bank Independence; Culture; European Central Bank; Franco- German relations
    JEL: E58 E52 F36 B52
    Date: 2011–11
  11. By: Gert Peersman (Ghent University, Sint-Pietersnieuwstraat 25, B-9000 Ghent, Belgium.)
    Abstract: I find that the Eurosystem can stimulate the economy beyond the policy rate by increasing the size of its balance sheet or the monetary base. The transmission mechanism turns out to be different compared to traditional interest rate innovations: (i) whilst the effects on economic activity and consumer prices reach a peak after about one year for an interest rate innovation, this is more than six months later for a shift in the monetary base that is orthogonal to the policy rate (ii) interest rate spreads charged by banks decline persistently after a rise in the monetary base, whereas the spreads increase significantly after a fall in the policy rate (iii) there is no significant short-run liquidity effect after an interest rate innovation, that is additional bank loans are generated by a greater credit multiplier. In contrast, the multiplier declines considerably after an expansion of the Eurosystem’s balance sheet. JEL Classification: C32, E30, E44, E51, E52.
    Keywords: Unconventional monetary policy, SVARs.
    Date: 2011–11
  12. By: Birmingham, Colin (Central Bank of Ireland); Conefrey, Thomas (Central Bank of Ireland)
    Abstract: This paper carries out an empirical analysis of the sensitivity of the Irish economy to an unanticipated external demand shock using a Bayesian VAR model which includes a number of Irish macroeconomic variables such as GDP, unemployment and wages. A 1% increase in US GDP growth leads to an increase in Irish GDP growth of 1.3% in the model. We also assess the relative importance of demand shocks in Ireland’s other key trading partners, the UK and the euro area. The Irish GDP response to shocks in our main trading partners is roughly proportional to our export shares to these regions. We feed the results of the VAR analysis into a mortgage delinquency model to derive the implication of changes in external demand on mortgage delinquency. The results suggest that a negative one standard deviation shock to US GDP growth leads to an increase of 1600 in the number of mortgages in arrears for at least 90 days.
    Keywords: Trade Shock, Bayesian VAR, Stress Testing
    JEL: F47 G21
    Date: 2011–10
  13. By: Bayoumi, Tamim; Bui, Trung
    Abstract: The financial crisis that struck the global economy in late 2008 had its origins in excesses in the US housing market. Its reverberations, however, were felt around the world and nowhere more keenly than in Western Europe. While North Atlantic trade links were in relative stasis, the North Atlantic furnished a uniquely close relationship across financial institutions, as a combination of dominant US financial markets, European competition policy, and differences in financial regulation made the European banking system heavily dependent on dollar wholesale funding. Empirical estimates and macroeconomic model simulations indicate that growth spillovers predominantly flow westwards across the North Atlantic. The bellwether nature of US financial markets creates uniquely large spillovers to the rest of the world even in normal times, and these spillovers are only enhanced if disruptions to bank wholesale funding markets are added -- as occurred during the recent global crisis.
    Keywords: economic crisis; financial deregulation; financial integration; North Atlantic economy
    JEL: E02 F34 N00 N10
    Date: 2011–12
  14. By: David Haugh
    Abstract: Ireland’s banking crisis, one of the most severe in the OECD area, and the associated economic recession have taken a heavy toll on public finances. Large public deficits have accumulated since 2008 and net public debt, which had been eliminated, has soared once again. The rapid deterioration of the fiscal accounts, together with the government guarantee of banks’ liabilities, has led to Ireland losing the confidence of the sovereign bond market and requiring financial assistance from the international community. With one of the highest levels of gross public debt relative to GDP in the OECD, high bond spreads and weak nominal GDP growth, returning to a healthy fiscal position poses a significant challenge. A sustained effort will be needed to eliminate the budget deficit, regain the confidence of financial markets and to seek to increase trend growth through appropriate structural reforms. The economic adjustment programme supported by the IMF and the EU foresees a gradual consolidation of the public finances to stabilise and reduce the debt to GDP ratio and restore fiscal sustainability. The programme builds on significant progress that has already been made to contain the deterioration of fiscal accounts and the government plans to introduce further fiscal adjustment in 2012 and later years in line with the programme. The programme also foresees a strengthening of the fiscal framework, with large institutional changes intended to secure a path of fiscal sustainability in the medium-term. The consolidation effort is also underpinned by efforts to increase public sector efficiency, which provides a growth-friendly avenue for reducing the deficit in a durable way.<p> This Working Paper relates to the 2011 OECD Economic Survey of Ireland (<P>Rétablir la viabilité budgétaire en Irlande<BR>La crise bancaire irlandaise, l’une des plus graves de la zone OCDE, et la récession qui l’a accompagnée ont lourdement pesé sur les finances publiques. Le pays connaît d’importants déficits depuis 2008 et la dette publique nette, qui avait été éliminée, est en forte résurgence. Á cause de la dégradation rapide des comptes budgétaires et de la garantie donnée par l’État aux engagements des banques, l’Irlande a perdu la confiance du marché des obligations souveraines et a dû recourir à l’aide de la communauté internationale. Sachant que le ratio dette brute/PIB est l’un des plus élevés de l’OCDE, que la prime sur les taux obligataires est importante et que la croissance du PIB nominal est faible, le retour à une situation budgétaire saine représente un sérieux défi. Un effort soutenu sera nécessaire pour résorber le déficit, regagner la confiance des marchés financiers et augmenter la croissance tendancielle par des réformes structurelles appropriées. Le programme d’ajustement économique soutenu par le FMI et l’UE prévoit un redressement graduel des finances publiques afin de stabiliser, puis de réduire, le ratio dette/PIB et de rétablir la viabilité budgétaire. Il s’appuie sur les progrès significatifs déjà réalisés, qui ont permis de contenir la dégradation des comptes budgétaires, et le gouvernement envisage de procéder en 2012 années suivants à un ajustement supplémentaire conforme au programme. Celui-ci prévoit aussi un renforcement du cadre de la gestion budgétaire comportant de grands changements institutionnels destinés à assurer la viabilité à moyen terme. L’effort de redressement bénéficie aussi des mesures prises pour rendre le secteur public plus efficace, ce qui est un moyen favorable à la croissance de réduire durablement le déficit. <p> Ce Document de travail se rapporte à l'Étude économique de l'OCDE de l’Irlande 2011 (
    Keywords: public debt, fiscal policy, public sector efficiency, public expenditure, fiscal rules, fiscal consolidation, debt sustainability, potential output, Ireland, fiscal frameworks, fiscal council, contestability, performance indicators, public sector agencies, dette publique, politique fiscale, dépenses publiques, efficience du secteur public, Irlande, consolidation budgétaire, règles fiscales, viabilité de la dette, conseil fiscal, cadre fiscal, contestabilité, indicateurs de performance, organismes du secteur public, croissance de production potentielle
    JEL: E62 E65 H11 H50 H61 H62 H63 H68
    Date: 2011–12–02
  15. By: Theilen, Bernd, 1965-; Herwartz, Helmut
    Abstract: Financial contributions to the EU budget depend basically on official GDP. This means that countries with higher shadow economic activity contribute less than they should contribute in a system based on actual GDP and therefore could reduce their incentive to fight against such activities. In this paper we investigate if the EU financing system really has an influence on the intensity with which governments in EU member states fight against shadow economic activity. We find that the EU net contributors significantly fight more intensively against shadow economic activity while EU net receivers significantly fight less. As a result, shadow economic activity is higher in net receiver and lower in net contributor countries than it were in comparison with a scenario of nationally balanced EU funding. Quantitatively and averaged over the time period 2001-2007, the diagnosed effect amounts to a stimulation of hidden economic activity by almost 10% for particular economies. JEL classification: C31, D63, F33, H21, H26. Keywords: EU financing system, shadow economy, tax auditing.
    Keywords: Finances públiques -- Unió Europea, Països de la, Pressupost -- Unió Europea, Països de la, Economia submergida, 339 - Comerç. Relacions econòmiques internacionals. Economia mundial. Màrqueting,
    Date: 2011
  16. By: Marina Tkalec (The Institute of Economics, Zagreb)
    Abstract: This paper investigates determinants of deposit euroization (DE) in twelve European post-transition economies using both linear and threshold models. Results suggest that exchange rates and interest rate differentials are important for explaining DE. Results for the two countries with the highest macroeconomic and institutional credibility and flexible exchange rate regimes, the Czech Republic and Poland, suggest no evidence of threshold effects, while for other countries threshold behavior was found. Threshold VAR results indicate depreciations have a stronger effect on DE than appreciations, while interest rate spreads widen more after exchange rate depreciations than after appreciations. Moreover, we found evidence that DE changes more strongly after interest rate differentials increase than after they decrease.
    Keywords: cointegration, deposit euroization, transition, threshold VAR
    JEL: C32 E44 E58 F31 F41
    Date: 2011–11
  17. By: Sala, Hector (Universitat Autònoma de Barcelona); Silva, José I. (University of Girona)
    Abstract: In this paper we show that vocational training is an important determinant of productivity growth. We construct a multi-country, multi-sectoral dataset, and quantify empirically to what extent vocational training has contributed to increase the growth rate of labor productivity in Europe between 1999 and 2005. We find that one extra hour of training per employee accelerates the rate of productivity growth by around 0.55 percentage points.
    Keywords: continuous vocational training, labor productivity growth
    JEL: E22 J24 O41
    Date: 2011–11
  18. By: Alessio Moro (University of Cagliari); Galo Nuño (Banco de España)
    Abstract: Housing prices diverge from construction prices after 1997 in four major countries. Besides, TFP differences between construction and the general economy account for the evolution of construction prices in the U.S. and Germany, but not in the U.K. and Spain.
    Keywords: Housing prices, TFP, growth accounting, Cobb-Douglas
    JEL: E01 E23 E25 E32
    Date: 2011–12
  19. By: Drinkwater, Stephen (Swansea University); Robinson, Catherine (Swansea University)
    Abstract: Welfare participation is an important indicator of how successfully immigrants perform in the host country. This paper examines this issue for the UK, which has experienced a large growth in its immigrant flows and population levels in recent years, especially following EU enlargement in 2004. The analysis focuses in particular on the types of benefits that immigrants tend to claim as well as examining differences by area of origin. It also examines the factors that determine social benefit claims, including an investigation of the impact of education, ethnicity and years since migration. Social welfare claims vary considerably by immigrant group as well as by the type of benefit claimed in the UK. There is also some variation by gender within the migrant groups.
    Keywords: immigration, United Kingdom, benefit claims, EU enlargement
    JEL: J61 F22 I38
    Date: 2011–11
  20. By: David Guerreiro; Valérie Mignon
    Abstract: We investigate price level convergence with Germany in eleven countries belonging to the Eurozone between January 1970 and July 2011. Relying on smooth transition regression models, we show that the price convergence process is nonlinear, depending on the size of the price differential: for most countries, price convergence occurs only when price differentials with Germany exceed a certain threshold. Moreover, our findings put forward some heterogeneity across the Eurozone members in terms of price convergence speed, that can be explained by the evolution of price-competitiveness, rigidities in labor markets, but also by specialization patterns.
    Keywords: price convergence, Eurozone, smooth transition regression models, half-life
    JEL: C22 E31 F15 F41
    Date: 2011

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