nep-eec New Economics Papers
on European Economics
Issue of 2012‒09‒03
eleven papers chosen by
Giuseppe Marotta
University of Modena and Reggio Emilia

  1. Does the halo effect still hold? Implications for the euro-candidates from the analysis of the EA bond market - the crisis perspective By Agnieszka Szczypińska
  2. Finance-dominated capitalism, re-distribution and the financial and economic crises: A European perspective By Hein, Eckhard
  3. The crisis of euro’s governance: institutional aspects and policy issues By Schilirò, Daniele
  4. Animal Spirits in the Euro Area Sovereign CDS Market By Blommestein, Hans J.; Eijffinger, Sylvester C W; Qian, Zongxin
  5. The role of uncertainty in the euro crisis: A reconsideration of liquidity preference theory By Pusch, Toralf
  6. Governance without government or: The Euro Crisis and what went wrong with European Economic Governance? By Heise, Arne
  7. Complexity and Monetary Policy By Orphanides, Athanasios; Wieland, Volker
  8. Asymmetric exchange rate pass-through in the Euro area: New evidence from smooth transition models By Ben Cheikh, Nidhaleddine
  9. The Euro and the global crises: finding the balance between short term stabilization and forward looking reforms By Aizenman, Joshua
  10. The optimal size of the European Stability Mechanism: A cost-benefit analysis By Daniel Kapp
  11. Labour market institutions and unemployment volatility: evidence from OECD countries By Faccini, Renato; Rosazza Bondibene, Chiara

  1. By: Agnieszka Szczypińska (Ministry of Finance, Poland)
    Abstract: The euro area bond yield spreads have largely converged since the beginning of the EMU. However, during the crisis most eurozone members reported dramatic rise in government bond yield differentials to German Bunds due to deteriorating public finance and liquidity conditions as well as increase in investors’ risk aversion. This paper provides an empirical analysis of determinants of government bond yield spreads in the euro area in the times of crisis. It indicates the significance of countries’ fiscal performance and liquidity risk in explaining the evolution of bond differentials. It also demonstrates the conviction that credit rating is a forward looking variable, which financial markets immediately respond to, was inappropriate. It is proved credit rating is only a derivative factor of fiscal variables, not the fundamental one. Sovereign debt crisis led to change in the perception of EMU sovereign debt market. Nowadays, euro adoption does not automatically imply the lower profitability of new EA members’ bonds. There is no more such a thing as “euro area level on interest rate”. It seems to be more conditional on countries’ macroeconomic policy. However, on the basis of panel estimation, it turned out that in case of almost all euro-candidates the theoretical values of the EMU convergence criterion bond yields (as they were the euro area members) would be significantly lower than the empirical ones. This suggests fiscal benefits from euro adoption might be substantial thus most countries with derogation should reassess their scale.
    Keywords: euro area, sovereign bond yield spreads, convergence criteria, panel data
    JEL: C23 E43 F34 H63
    Date: 2012–08–29
  2. By: Hein, Eckhard
    Abstract: In this paper the euro crisis is viewed as the most recent episode of the crisis of financedominated capitalism. Therefore, two major features of finance-dominated capitalism, the increasing inequality of income distribution and the rising imbalances of current accounts, are analysed for a set of major Euro area countries. Against this background the euro crisis is examined, and it is shown that the economic policy reactions of European governments and institutions, narrowly interpreting the crisis as a sovereign debt crisis caused by irresponsible behaviour of some member country governments, are misguided and will lead to deflationary stagnation and an increasing risk of disintegration of the Euro area. For this reason, an alternative macroeconomic policy approach tackling the basic contradictions of financedominated capitalism and the deficiencies of European economic policy institutions and economic policy strategies is outlined. It is argued that, on the one hand, an institution which convincingly guarantees the public debt of Euro area member countries and, on the other hand, an expansionary macroeconomic policy approach, in particular in the current account surplus countries of the Euro area, need to be introduced. --
    Keywords: Finance-dominated capitalism,distribution,financial and economic crisis,European economic policies
    JEL: E25 E58 E61 E63 E64 E65
    Date: 2012
  3. By: Schilirò, Daniele
    Abstract: The European Monetary Union is characterized by a crisis of governance, this has become more evident with the crisis of the euro which has shown the weaknesses of the European institutions and stressed the heterogeneity of member countries. The global financial crisis struck the euro area very severely because it coincided with the lack of appropriate policy tools to manage the crisis and with a period of weak political leadership which have made crisis management even harder. Europe needs to build the institutions of its monetary union to avoid similar crises in the future. But it is necessary a greater European integration, with a central fiscal entity at European level which requires a transfer of sovereignty from the individual Member States. This contribution first discusses the issue concerning rules and discretion in the governance of the euro. In the following section it describes the euro crisis and examines the remedies put in place, noting that despite the statements and the efforts of the European authorities the confidence in the euro is diminishing. Thus the exit of Greece from the euro or even the breakdown of the single currency has become a hypothesis discussed more frequently among economists, politicians, central bankers and businessmen. The last section of the work focuses on what’s wrong in the governance of the euro and examines the institutional aspects and the economic policy issues suggesting that the European integration serves to ensure the European citizens independence and protect their historical freedom, but also to influence and thus affect the choices from which may depend the future prosperity of European nations involved.
    Keywords: euro; crisis of governance; European integration; European institutions; economic policies
    JEL: F15 F34 F43 F33 O52 F36
    Date: 2012–01
  4. By: Blommestein, Hans J.; Eijffinger, Sylvester C W; Qian, Zongxin
    Abstract: We study the determinants for the sovereign credit default swap (CDS) spreads of five Euro-area countries (Greece, Ireland, Italy, Portugal, Spain) in the post-Lehman-Brothers period. We find that there are regime switches in the process of sovereign CDS spread changes. We consider three alternative empirical hypotheses associated with regime switches. Under the first hypothesis, there are rational sunspot equilibria. Under the second hypothesis, there is a unique fundamental equilibrium and the regime switching is caused by changes in policy makers' preferences. The third hypothesis relaxes the rational expectations assumption. Under this hypothesis, indicators of the market fundamentals are not always precise. They are better indicators if cognitive biases are small and the rational expectations economy is a good approximation for reality. However, if market uncertainties enlarge the cognitive biases, the market-based indicators of fundamentals are no longer precise. In this case, they are not useful for CDS pricing. We find that the first two hypotheses are difficult to fit the data and the third hypothesis provides a good explanation for the sovereign CDS spread dynamics in our sample.
    Keywords: Animal spirit; Euro; sovereign CDS
    JEL: F34 G15 P34
    Date: 2012–08
  5. By: Pusch, Toralf
    Abstract: An active role of fiscal policy has been rediscovered as a crisis remedy at the beginning of the financial crisis all over Europe. More recently, the Euro Crisis with its mounting governments' funding costs for a number of Southern EU member states and Ireland has called this strategy into question. As opposed to this view, the main point of this contribution is to elaborate a link between rising sovereign risk premia in the Eurozone and a major feature of the financial crisis - which culminated in elevated uncertainty after the Lehman collapse. Theoretically, this link is developed with a reference to Keynes' liquidity preference theory. Empirically, a high explanatory power of rising uncertainty in financial markets and detrimental effects of fiscal austerity for the evolution of sovereign risk spreads are demonstrated by means of panel regressions and supplementary correlation analyses. --
    JEL: E12 E62 G12
    Date: 2012
  6. By: Heise, Arne
    Abstract: The Great Recession after 2008 did not turn out to be as deep and severe as the Great Depression of the 1930s. According to the European Commission, this positive result is due to the fact that economic policy-makers around the world learnt their lessons from the Great Depression in stabilizing their financial systems and, moreover, that particularly the European Union and its economic governance system has become a shelter against negative external shocks in coordinating stabilization policies to maintain aggregate demand. This paper argues that the claim of the European Commission needs some qualifications: on the one hand, the lessons have not been applied appropriately in all EU and, particularly, Eurozone Member States. This is, on the other hand, not merely the result of mismanagement of individual governments but the systematic outcome of an ineffective and even counterproductive European economic governance system. Although, in the wake of the Euro Crisis some crisis control and emergency measures have been established, crisis resolution has failed as the core of the inefficient governance system - the European Stability and Growth Pact (ESGP) - has not been reformed adequately. --
    Keywords: Euro Crisis,European Governance,Economic Policy
    JEL: B59 F15 H30 N10
    Date: 2012
  7. By: Orphanides, Athanasios; Wieland, Volker
    Abstract: The complexity resulting from intertwined uncertainties regarding model misspecification and mismeasurement of the state of the economy defines the monetary policy landscape. Using the euro area as laboratory this paper explores the design of robust policy guides aiming to maintain stability in the economy while recognizing this complexity. We document substantial output gap mismeasurement and make use of a new model data base to capture the evolution of model specification. A simple interest rate rule is employed to interpret ECB policy since 1999. An evaluation of alternative policy rules across 11 models of the euro area confirms the fragility of policy analysis optimized for any specific model and shows the merits of model averaging in policy design. Interestingly, a simple difference rule with the same coefficients on inflation and output growth as the one used to interpret ECB policy is quite robust as long as it responds to current outcomes of these variables.
    Keywords: complexity; ECB; Financial crisis; model uncertainty; monetary policy; robust simple rules
    JEL: E50 E52 E58
    Date: 2012–08
  8. By: Ben Cheikh, Nidhaleddine
    Abstract: This paper examines the presence of asymmetric behavior in exchange rate pass-through (ERPT) to CPI inflation in 12 euro area (EA) countries. Using a class of nonlinear smooth transition models, we test for asymmetry with respect to the direction and the magnitude of exchange rate changes. On the one hand, we find only 5 out of 12 EA countries showing asymmetric pass-through to exchange rate appreciations and depreciations. Results are somewhat mixed with no clear evidence about the direction of asymmetry. On the other hand, we report strong evidence that ERPT responds asymmetrically to the size of exchange rate changes as a result of presence of menu costs. The degree of ERPT is found to be higher for large exchange rate changes than for small ones in 9 out of 12 EA countries. --
    Keywords: exchange rate pass-through,inflation,smooth transition regression models,euro area
    JEL: C22 E31 F31 F41
    Date: 2012
  9. By: Aizenman, Joshua
    Abstract: This paper analyzes reforms and adjustments in the context of the Euro and the global financialcrises. Taking the perspective of the evolutionary approach to institutions, the formation of a newcurrency area is not unidirectional. The process leading to the euro is an example of a commonupbeat and optimistic attitude to the formation of new institutions. Such a Panglossian attitude topolicies may reflect built-in fiscal myopia, possibly both at the level of the principal [the policymaker] and of the agents [consumers and households]. Next, the paper reviews the evolution ofinstitutions buffering the stability of unions in the aftermath of crises, where fiscal restraints andthe allocation of significant bargaining clout to the Federal Center increase the stability of aunion. The paper concludes with an overview of the challenges associated with finding theproper balance between financial integration and financial regulations
    Keywords: Economics, currency unions, financial regulations, financial reforms, evolutionary approach to institutions
    Date: 2012–05–26
  10. By: Daniel Kapp
    Abstract: This study presents a core-periphery model to determine the optimal size of the European Stability Mechanism (ESM), building on Jeanne and Ranciere (2011). While the periphery is subject to a probability of losing access to external credit, the core's incentive for setting up an ESM stems exclusively from the spillover effects present in the case of periphery default. The model develops regional best response functions, determining a set of feasible ranges for the total ESM size, given optimal regional contributions. The model is then calibrated to the European Economic and Monetary Union. If costs from default are reasonably high, the probability of the periphery not having access to external credit is sufficiently large, and spillover effects to the core are present, both the core and the periphery have an interest in contributing to the ESM. Calibration and sensitivity analysis suggest that the optimal ESM size is between the current and twice the size of the agreed-upon ESM.
    Keywords: ESM; ESFR; Financial Crisis; Insurance
    JEL: G01 G17 G22 G32 C15
    Date: 2012–08
  11. By: Faccini, Renato (Queen Mary, University of London); Rosazza Bondibene, Chiara (NIESR and Royal Holloway, University of London)
    Abstract: Using publicly available data for a group of 20 OECD countries, we find that the cyclical volatility of the unemployment rate exhibits substantial cross-country and time variation. We then investigate empirically whether labour market institutions can account for this observed heterogeneity and find that the impact of various institutions on cyclical unemployment dynamics is quantitatively strong and statistically significant. The hypothesis that labour market institutions could increase the volatility of unemployment by reducing match surplus is not supported by the data. In fact, unemployment benefits, taxation and employment protection appear to reduce the volatility of unemployment rates. In addition, we find that the precise nature of union bargaining has important implications for cyclical unemployment dynamics, with union coverage and density having large and offsetting effects. Finally, we provide evidence suggesting that interactions between shocks and institutions matter for cyclical unemployment fluctuations. However, institutions only account for about one quarter of the explained variation, which implies that they are important but they are not the entire story.
    Keywords: Labour market institutions; labour market fluctuations
    JEL: E32 E60 J01 J08
    Date: 2012–08–21

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