nep-eec New Economics Papers
on European Economics
Issue of 2012‒05‒22
fourteen papers chosen by
Giuseppe Marotta
University of Modena and Reggio Emilia

  1. Credit and Liquidity Risks in Euro-area Sovereign Yield Curves By Alain Monfort; Jean-Paul Renne
  2. External imbalances and financial fragility in the euro area By Pietro Alessandrini; Michele Fratianni; Andrew Hughes Hallett; Andrea Filippo Presbitero
  3. "The Euro Debt Crisis and Germany's Euro Trilemma" By Jorg Bibow
  4. "What Are the Driving Factors behind the Rise of Spreads and CDSs of Euro-area Sovereign Bonds? A FAVAR Model for Greece and Ireland" By Nicholas Apergis; Emmanuel Mamatzakis
  5. Putting currency misalignment into gravity: The currency union effect reconsidered By Hogrefe, Jan; Jung, Benjamin; Kohler, Wilhelm K.
  6. Milton Friedman, the Demand for Money and the ECB’s Monetary-Policy Strategy By Stephen Hall; P.A.V.B. Swamy; George S. Tavlas
  7. Exchange Return Co-movements and Volatility Spillovers Before and After the Introduction of Euro By Nikolaos Antonakakis
  8. Financial liberalization, growth, productivity and capital accumulation: The case of European integration By Agnieszka Gehringer
  9. Automatic Fiscal Stabilisers: What they are and what they do By Jan in 't Veld; Martin Larch; Marieke Vandeweyer
  10. Europe 2020 and national reforms: economic governance and structural reforms By Paolo Sestito; Roberto Torrini
  11. The European Union's service directive: Contrasting ex ante estimates with empirical evidence By Bianka Dettmer
  12. Bringing Belgian Public Finances to a Sustainable Path By Tomasz Koźluk Koźluk; Alain Jousten; Jens Høj
  13. Does Wagner's law ruin the sustainability of German public finances? By Priesmeier, Christoph; Koester, Gerrit B.
  14. The Post-2007 Crises and Europe's Place in the Global Economy. By Richard Pomfret

  1. By: Alain Monfort (CREST, University of Maastricht); Jean-Paul Renne (Banque de France)
    Keywords: default risk, liquidity risk, term structure of interest rates, regime switching, euro-area spreads
    JEL: E43 E44 E47 G12 G24
    Date: 2011–07
  2. By: Pietro Alessandrini (Universit… Politecnica delle Marche, MoFiR); Michele Fratianni (Indiana University, Kelly School of Business, Bloomington US, Univ. Plitecnica Marche and MoFiR); Andrew Hughes Hallett (George Mason University); Andrea Filippo Presbitero (Universit… Politecnica delle Marche, MoFiR)
    Abstract: This paper presents two views of the European sovereign debt crisis. The first is that the South in the euro zone has been fiscally irresponsible, and has failed to implement supply-side policies such as liberalizing labor markets and the market for services. The second view holds that the crisis reflects a deep divide between the external surpluses of the North and external deficits of the South. Basic stylized facts raise some doubt about the validity of the thesis that the debt crisis in the Eurozone is driven primarily by fiscal fragility in the South. A relatively simple model shows how poor fundamentals can create a debt problem independently of fiscal responsibility. The empirical analysis of the determinants of government bond yield spreads relative to Germany suggests that both views in fact provide useful insights into the roots of the current sovereign crisis. Fiscal fragility and external imbalances explain a significant share of the widening spreads since the onset of the global financial crisis. However, differences in labor productivity growth between North and South assume a much relevant role since the Greek crisis erupted in 2010.
    Keywords: Sovereign yield spreads, adjustment burden, external imbalances, monetary union
    JEL: F32 F42 G12 H63
    Date: 2012–05
  3. By: Jorg Bibow
    Abstract: This paper investigates the causes behind the euro debt crisis, particularly Germany's role in it. It is argued that the crisis is not primarily a "sovereign debt crisis" but rather a (twin) banking and balance of payments crisis. Intra-area competitiveness and current account imbalances, and the corresponding debt flows that such imbalances give rise to, are at the heart of the matter, and they ultimately go back to competitive wage deflation on Germany's part since the late 1990s. Germany broke the golden rule of a monetary union: commitment to a common inflation rate. As a result, the country faces a trilemma of its own making and must make a critical choice, since it cannot have it all--perpetual export surpluses, a no transfer / no bailout monetary union, and a "clean," independent central bank. Misdiagnosis and the wrongly prescribed medication of austerity have made the situation worse by adding a growth crisis to the potpourri of internal stresses that threaten the euro's survival. The crisis in Euroland poses a global "too big to fail" threat, and presents a moral hazard of perhaps unprecedented scale to the global community.
    Keywords: Euro; Monetary Union; Banking Crisis; Balance-of-Payments Crisis; Sovereign Debt Crisis; Competitiveness Imbalances; Fiscal Transfers; Bailouts; Austerity
    JEL: E42 E52 E58 E65 F36 G01
    Date: 2012–05
  4. By: Nicholas Apergis; Emmanuel Mamatzakis
    Abstract: This paper examines the underlying dynamics of selected euro-area sovereign bonds by employing a factor-augmenting vector autoregressive (FAVAR) model for the first time in the literature. This methodology allows for identifying the underlying transmission mechanisms of several factors; in particular, market liquidity and credit risk. Departing from the classical structural vector autoregressive (VAR) models, it allows us to relax limitations regarding the choice of variables that could drive spreads and credit default swaps (CDSs) of euro-area sovereign debts. The results show that liquidity, credit risk, and flight to quality drive both spreads and CDSs of five years' maturity over swaps for Greece and Ireland in recent years. Greece, in particular, is facing an elastic demand for its sovereign bonds that further stretches liquidity. Moreover, in current illiquid market conditions spreads will continue to follow a steep upward trend, with certain adverse financial stability implications. In addition, we observe a negative feedback effect from counterparty credit risk.
    Keywords: Sovereign Debt Crisis; Spreads; CDS; FAVAR Model; Greece and Ireland
    JEL: C32 G00 G01
    Date: 2012–05
  5. By: Hogrefe, Jan; Jung, Benjamin; Kohler, Wilhelm K.
    Abstract: Member countries of a currency union like the euro area have absorbed asymmetric shocks in ways that are inconsistent with a common nominal anchor. Based on a reformulation of the gravity model that allows for such bilateral misalignment, we disentangle the conventional microeconomic trade effect and macroeconomic trade effects deriving from bilateral misalignment within currency unions. Econometric estimation reveals that for the euro area the misalignment channel exerts a significant trade effect on bilateral exports. We retrieve country-specific estimates of the misalignment-induced effect on trade which demonstrate heterogeneous outlooks across countries for the costs and benefits from adopting the euro. --
    Keywords: Euro,gravity model,exchange rates,trade imbalances
    JEL: F12 F13 F15
    Date: 2012
  6. By: Stephen Hall; P.A.V.B. Swamy; George S. Tavlas
    Abstract: The European Central Bank (ECB) assigns a greater weight to the role of money in its monetary-policy strategy than most, if not all, other major central banks. Nevertheless, reflecting the view that the demand for money became unstable in the early-2000s, some commentators in the press have reported that the ECB has “downgraded” the role of money-demand functions in its strategy. This paper explains the ECB’s monetary-policy strategy and shows the considerable influence of Milton Friedman’s contributions on the formulation of that strategy. The paper also provides new evidence on the stability of euro-area money-demand. Following a conjecture made by Friedman (1956), we assign a role to uncertainty in the money-demand function. We find that, although uncertainty is mean–reverting, it is none-the-less non-stationary, subject to wide swings, and has substantial effects on the demand for money.
    Keywords: ECB’s monetary-policy strategy; Milton Friedman; money demand
    JEL: C20 E41
    Date: 2012–04
  7. By: Nikolaos Antonakakis
    Abstract: This paper examines co-movements and volatility spillovers in the returns of the euro, the British pound, the Swiss franc and the Japanese yen vis-à-vis the US dollar before and after the introduction of the euro. Based on dynamic correlations, variance decompositions, generalized VAR analysis, and a newly introduced spillover index, the results suggest significant co-movements and volatility spillovers across the four exchange returns, but their extend is, on average, lower in the latter period. Return co-movements and volatility spillovers show large variability though, and are positively associated with extreme economic episodes and, to a lower extend, with appreciations of the US dollar. Moreover, the euro (Deutsche mark) is the dominant currency in volatility transmission with a net volatility spillover of 8% (15%) to all other markets, while the British pound is the dominant net receiver of volatility with a net volatility spillover of -11% (-13%), in the post- (pre-) euro period. The nature of crossmarket volatility spillovers is found to be bidirectional though, with the highest volatility spillovers occurring between the European markets. The economic implications of these findings for central bank interventions, international portfolio diversification and currency risk management are then discussed.
    Keywords: Exchange returns co-movement, Volatility spillover, Vector autoregression, Variance decomposition, Spillover index, Multivariate GARCH
    JEL: C32 F31 G15
    Date: 2012–05
  8. By: Agnieszka Gehringer
    Abstract: In the present contribution, we concentrate on the process of financial liberalization in a specific context of European economic and monetary integration. We implement de facto and de jure measures of financial liberalization and find that formal aspects of financial openness generate a strongly positive impact on economic growth and its sources, productivity growth and capital accumulation. Moreover, there is evidence of a positive contribution to the process stemming from the EU membership, while no substantial effect comes from the euro adoption. Finally, we investigate the effects from financial integration on country groups within the EU.
    Keywords: Financial integration, economic growth, productivity, European integration
    JEL: F41 F36 F43
    Date: 2012–05
  9. By: Jan in 't Veld; Martin Larch; Marieke Vandeweyer
    Abstract: The global financial and economic crisis has revived the debate in the academic literature and in policy circles about the size and effectiveness of automatic fiscal stabilisers. Especially in the euro area where monetary policy is centralised and discretionary fiscal policy making is constrained by the EU fiscal rules, knowing the size and the effectiveness of automatic stabilisers is crucial. While automatic stabilisers are a fairly established concept in the fiscal policy literature, there is still no consensus about their actual nature and their effectiveness. This paper shows that differences in opinion mirror a deeper disagreement over how the budget would look like without automatic stabilisers. This issue is addressed by defining two types of counterfactual budgets giving rise to two different interpretations about the nature of automatic stabilisation. Simulations with a structural model confirm that the degree of smoothing is conditional on how the counterfactual budget, i.e. the budget without automatic stabilisers, is defined.
    JEL: H6 H30 E37 E62
    Date: 2012–04
  10. By: Paolo Sestito (Bank of Italy); Roberto Torrini (Bank of Italy and ANVUR)
    Abstract: Structural reforms are stressed in Europe 2020 as a tool for boosting economic growth and improving social cohesion. Yet tensions often arises between country specificities and goals, on one side, and pressures by partners and EU wide goals on the other side. The paper discusses the European economic governance issues building upon a sketchy historical account of the so called Open Method of Coordination. It is argued that the structural reforms’ success depends upon aspects like the variety, ex ante identifiability and easiness to organize of their potential supporters as well as the presence of institutional mechanisms through which it is possible to compensate the potential losers and/or distributing on wider and fairer basis their benefits; furthermore mechanisms capable to contrast the shortsightedness of many political decisions, also favouring the political participation of all often silent stakeholders, are argued as essential. The most important contribution from EU wide pressures and rules is identified in the capacity building of national institution, to be based also upon stringent rules, aiming at fostering national governments’ accountability and the policy evaluation tools.
    Keywords: Structural reforms, Economic Governance, EU2020, Open Method of Coordination
    JEL: F55 H79 O43
    Date: 2012–04
  11. By: Bianka Dettmer (Friedrich-Schiller-University of Jena, Chair of Economic Policy)
    Abstract: One of the top priorities to improve the European Union's growth performance is the creation ofsingle market for services. The directive on services adopted by the Parliament and the Council by the end of 2006 aims at removing barriers to the free movement of service providers on the internal market. Previous studies quantified ex ante sizable effects of implementing the directive in its original form. This paper is a first attempt to evaluate ex post the trade effects induced by a directive - which excludes the country-of-origin principle - by performing a difference-in-difference-(in-differences) estimator on a sample of EU- and non-EU countries in the period 2004 to 2010. We account for non-tariff trade barriers and the endogeneity of regional trade agreements and find that deregulations foster a deeper integration of the new member states into the European value-added-chain and promote business service exports from third countries towards the EU. The reorientation of the new members is in turn associated with declining intra-EU10 business intensities while leaving business trade among the entire members largely unaffected.
    Keywords: service directive, non-tariff barriers, outsourcing, internal market, EU
    JEL: F12 F15 L84
    Date: 2012–05–07
  12. By: Tomasz Koźluk Koźluk; Alain Jousten; Jens Høj
    Abstract: Economic growth is projected to be strengthening from mid-2011 onwards, but will be insufficient to restore the sustainability of public finances. The Belgian strategy to prefund ageing costs by generating fiscal surpluses to bring down public debt was derailed by the global crisis. Restoring the strategy is a priority, especially as spreads on Belgian debt have increased. This will require cuts in public spending, improving efficiency of policies, containing the growth of ageing-related costs and making the tax system more conducive to growth. While past experiences, such as in the 1990s, have shown that successful large consolidations are feasible, the task seems even more difficult this time as potential growth will be muted and interest rates are likely to increase. In this context, a credible fiscal consolidation plan requires the participation of all governments. Its effectiveness can be strengthened by improving the fiscal framework, in particular by introducing multi-year budgets, annual expenditure rules consistent with long-term targets and an enhanced role of an independent fiscal policy watchdog.<P>Mettre les finances publiques belges sur la voie de la viabilité<BR>On prévoit un renforcement de la croissance à partir du milieu de 2011, mais il ne suffira pas à rétablir la viabilité des finances publiques. La stratégie suivie par la Belgique, qui consistait à préfinancer le coût du vieillissement en dégageant des excédents budgétaires permettant de diminuer la dette publique, a été compromise par la crise mondiale. En revenir à cette stratégie est une priorité, d’autant plus que la prime de risque sur les taux d’intérêt de la dette belge a augmenté. Cela exigera de faire des économies, d’améliorer l’efficience des politiques publiques, de contenir la hausse des charges liées au vieillissement de la population et de rendre le système fiscal plus favorable à la croissance. Les expériences passées, par exemple celle des années 1990, ont démontré la possibilité d’effectuer un assainissement en profondeur, mais la tâche semble cette fois plus difficile ; en effet, la croissance potentielle sera très modérée et les taux d’intérêt vont probablement augmenter. Dans ces conditions, pour qu’un plan de redressement budgétaire soit crédible, tous les gouvernements doivent y participer. On peut lui donner plus d’efficacité en améliorant le cadre d’action, notamment par l’instauration de budgets pluriannuels et la fixation de règles de dépenses annuelles conformes aux objectifs à long terme ainsi qu’en faisant jouer un rôle accru à une entité indépendante chargée de surveiller la politique budgétaire.
    Keywords: public debt, public finances, tax policy, Belgium, fiscal federalism, social security, fiscal sustainability, budgetary rules, fiscal councils, dette publique, finances publiques, fédéralisme fiscal, sécurité sociale, Belgique, viabilité budgétaire, règle budgétaire, conseil fiscal
    JEL: E60 E61 H60 H61 H63 H77
    Date: 2012–04–26
  13. By: Priesmeier, Christoph; Koester, Gerrit B.
    Abstract: The empirical and theoretical literature on long-term relationships in public finance is dominated by two approaches: Fiscal sustainability and Wagner's law of an increasing state activity. In this paper, we argue that these two relationships should be analyzed simultaneously and not separately. We show how Wagner's law might influence fiscal sustainability and how the interaction of the two can be modelled using vector error correction models that include public expenditures, revenues and GDP. For Germany, we find strong evidence for Wagner's law throughout the whole period analyzed (1960-2007), while our results indicate sustainability of public finances only until 1973. We show that, for the period after 1973, it is the interaction of permanent expenditure increases and revenue reductions resulting from fiscal policy reactions to the oil crisis and Wagner's law that ruins the sustainability of public finances in Germany. Our findings underline the importance of the German debt brake for re-establishing sustainable public finances even under Wagner's law. --
    Keywords: Fiscal sustainability,Wagner's law,Structural breaks,Cointegration,Vector error correction models
    JEL: H63 H19 H50 E62
    Date: 2012
  14. By: Richard Pomfret
    Abstract: What is often abbreviated to GFC included three distinct crises: the 2007-8 North Atlantic financial crisis, a 2008-9 global economic crisis and public finance crises which became increasingly focussed on the eurozone in 2010-12. The relative weight of emerging market economies in the global economy, which had been increasing for several decades, grew even more rapidly in 2008-11 as the economies of the USA and Europe faltered, and other open economies recovered rapidly from the global economic crisis. This poses challenges for global economic governance, although there are constraints on Asia being a more assertive force. For the EU the greater dangers are, first, that if EU leaders see their economies as victims of a GFC then they will fail to address their economies’ own shortcomings, and, second, that preoccupation with internal crises will distract EU leaders from rising to the challenges and opportunities associated with the evolving multipolar global economy.
    Keywords: Financial crises, Global economy, Multipolar world
    JEL: G01 O53 F40
    Date: 2012

This nep-eec issue is ©2012 by Giuseppe Marotta. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.