nep-eec New Economics Papers
on European Economics
Issue of 2012‒09‒30
fifteen papers chosen by
Giuseppe Marotta
University of Modena and Reggio Emilia

  1. The interplay of economic reforms and monetary policy: the case of the Euro area By Francesco Drudi; Alain Durré; Francesco Paolo Mongelli
  2. Recent estimates of sovereign risk premia for euro-area countries By Antonio Di Cesare; Giuseppe Grande; Michele Manna; Marco Taboga
  3. Over-Optimistic Official Forecasts in the Eurozone and Fiscal Rules By Frankel, Jeffrey A.; Schreger, Jesse
  4. Revisiting the effective exchange rates of the Euro By Martin Schmitz; Maarten De Clercq; Michael Fidora; Bernadette Lauro; Cristina Pinheiro
  5. Loan supply shocks and the business cycle By Luca Gambetti; Alberto Musso
  6. Nonlinear Mechanism of the Exchange Rate Pass-Through: Does Business Cycle Matter? By Nidhaleddine Ben Cheikh
  7. Financial Crisis and Domino Effect By Pedro Bação; João Maia Domingues; António Portugal Duarte
  8. Does Emigration Benefit the Stayers? Evidence from EU Enlargement By Elsner, Benjamin
  9. Shadow banking in the Euro area: an overview By Klára Bakk-Simon; Stefano Borgioli; Celestino Giron; Hannah Sabine Hempell; Angela Maddaloni; Fabio Recine; Simonetta Rosati
  10. The Case For Temporary Inflation in the Eurozone By Schmitt-Grohé, Stephanie; Uribe, Martín
  11. Explaining EU Citizens' Trust in the ECB in Normal and Crisis Times By Ehrmann, Michael; Soudan, Michel; Stracca, Livio
  12. The use of the Eurosystem's monetary policy instruments and operational framework since 2009 By Fabian Eser; Marta; Stefano Iacobelli; Marc Rubens
  13. Fiscal rules: Timing is everything By Benedicta Marzinotto; André Sapir
  14. Fiscal forecast errors: governments vs independent agencies? By Rossana Merola; Javier J. Pérez
  15. Will Solvency II market risk requirements bite? The impact of Solvency II on insurers' asset allocation By Höring, Dirk

  1. By: Francesco Drudi (European Central Bank, Kaiserstraße 29, D-60311 Frankfurt am Main, Germany.); Alain Durré (European Central Bank, Kaiserstraße 29, D-60311 Frankfurt am Main, Germany; IESEG-School of Management (Lille Catholic University) and LEM-CNRS (UMR 8179).); Francesco Paolo Mongelli (European Central Bank, Kaiserstraße 29, D-60311 Frankfurt am Main, Germany; Goethe University Frankfurt.)
    Abstract: The world has been struck by a mutating systemic financial crisis that is unprecedented in terms of financial losses and fiscal costs, geographic reach, and speed and synchronisation. The crisis from August 2007 to date can be divided into three main phases: the financial turmoil from August 2007 to the collapse of Lehman Brothers; the global financial crisis from September 2008 until spring 2010; and the euro area sovereign debt crisis from spring 2010 to the current period. While each phase has brought significant challenges, the current sovereign debt crisis has been the most critical stage for the euro area. It has brought unprecedented challenges for the monetary union and triggered extraordinary adjustments in both monetary policy and institutional arrangements at the euro area level. The purpose of this article is to outline the features of each crisis phase, to describe the actions taken by the European Central Bank (ECB) during each phase and to explain the rationale for such measures. It also discusses the need to strengthen further the economic union in order to guarantee the sustainability of the monetary union of the euro area. In this respect, it is argued that the recent institutional adjustments made at the EU level would have been necessary independently of the financial crisis. JEL Classification: D78, E52, E58, G01, H12
    Keywords: Monetary policy decision-making, Eurosystem, financial crisis, financial and institutional reforms
    Date: 2012–09
  2. By: Antonio Di Cesare (Bank of Italy); Giuseppe Grande (Bank of Italy); Michele Manna (Bank of Italy); Marco Taboga (Bank of Italy)
    Abstract: This paper examines the recent behavior of sovereign interest rates in the euro area, focusing on the 10 year yield spreads relative to Germany for Italy and other euro area countries. Both previous analyses and the new evidence presented in the paper suggest that, in recent months, for several countries the spread has increased to levels that are well above those that could be justified on the basis of fiscal and macroeconomic fundamentals. Among the possible reasons for this gap, the analysis focuses on the perceived risk of a break up of the euro area.
    Keywords: interest rates, government yield spreads, sovereign risk premia, government debt, financial crisis, sovereign debt crisis, financial contagion, euro break up, convertibility risk
    JEL: G12 E43 E62 H63
    Date: 2012–09
  3. By: Frankel, Jeffrey A. (Harvard University); Schreger, Jesse (Harvard University)
    Abstract: Why do countries find it so hard to get their budget deficits under control? Systematic patterns in the errors that official budget agencies make in their forecasts may play an important role. Although many observers have suggested that fiscal discipline can be restored via fiscal rules such as a legal cap on the budget deficit, forecasting bias can defeat such rules. The members of the eurozone are supposedly constrained by the fiscal caps of the Stability and Growth Pact. Yet ever since the birth of the euro in 1999, members have postponed painful adjustment by making overly optimistic forecasts of future growth and budget positions and arguing that the deficits will fall below the cap within a year or two. The new fiscal compact among the euro countries is supposed to make budget rules more binding by putting them into laws and constitutions at the national level. But what is the record with such national rules? Our econometric findings are summarized as follows: -Governments' budget forecasts are biased in the optimistic direction, especially among the Eurozone countries, especially when they have large contemporaneous budget deficits, and especially during booms. -Governments' real GDP forecasts are similarly over-optimistic during booms. -Despite the well-known tendency of eurozone members to exceed the 3% cap on budget deficits, often in consecutive years, they almost never forecast that they will violate the cap in the coming years. This is the source of the extra bias among eurozone forecasts. If euro area governments are not in violation of the 3% cap at the time forecasts are made, forecasts are no more biased than other countries. -Although euro members without national budget balance rules have a larger over-optimism bias than non-member countries, national fiscal rules help counteract the wishful thinking that seems to come with euro membership. The reason is that when governments are in violation of the 3% cap the national rules apparently constrain them from making such unrealistic forecasts. -Similarly, the existence of an independent fiscal institution producing budget forecasts at the national level reduces the over-optimism bias of forecasts made when the countries are in violation of the 3% cap.
    JEL: E62 H20
    Date: 2012–09
  4. By: Martin Schmitz (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Maarten De Clercq (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Michael Fidora (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Bernadette Lauro (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Cristina Pinheiro (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main)
    Abstract: This paper describes in detail the methodology currently used by the European Central Bank (ECB) to determine the nominal and real effective exchange rate indices of the euro. Building on the work of Buldorini et al. (2002), it shows how the ECB’s techniques for calculating effective exchange rates have been updated over time and explains the related theoretical foundations. In particular, the paper discusses the use and development of trade weights based on trade in manufactured goods (taking account of third market effects), the trading partners selected, and the choice of deflators for constructing the real effective exchange rate indices. In addition, it presents evidence on exchange rate and competitiveness developments for both the euro area as a whole and individual Member States. While the growing importance of China is reflected in the updated trade weights of euro effective exchange rates, it appears that the increasing integration of the euro area with other European economies accounts for the largest variation in trade weights. The US dollar, an anchor currency for a number of large emerging markets, continues to play an important role for the effective exchange rate of the euro and euro area competitiveness. Overall, euro area competitiveness has improved slightly since the introduction of the single currency, despite significant heterogeneity within the euro area. JEL Classification: F10, F30, F31, F40
    Keywords: competitiveness, effective exchange rate (EER), harmonised competitiveness indicator (HCI), nominal effective exchange rate (NEER), real effective exchange rate (REER), trade weights
    Date: 2012–06
  5. By: Luca Gambetti (Universitat Autonoma de Barcelona, B3.1130 Departament d’Economia i Historia Economica, Edifici B, Bellaterra 08193, Barcelona, Spain.); Alberto Musso (European Central Bank, Kaiserstraße 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: This paper provides empirical evidence on the role played by loan supply shocks over the business cycle in the Euro Area, the United Kingdom and the United States from 1980 to 2010 by applying a time-varying parameters VAR model with stochastic volatility and identifying these shocks with sign restrictions. The evidence suggests that loan supply shocks appear to have a significant effect on economic activity and credit market variables, but to some extent also inflation, in all three economic areas. Moreover, we report evidence that the short-term impact of these shocks on real GDP and loan volumes appears to have increased in all three economic areas over the past few years. The results of the analysis also suggest that the impact of loan supply shocks seems to be particularly important during slowdowns in economic activity. As regards to the most recent recession, we find that the contribution of these shocks can explain about one half of the decline in annual real GDP growth during 2008 and 2009 in the Euro Area and the United States and possibly about three fourths of that observed in the United Kingdom. Finally, the contribution of loan supply shocks to the decline in the annual growth rate of loans observed from the peaks of 2007 to the troughs of 2009/2010 was slightly less than half of the total decline in the Euro Area and the United States and somewhat more than half of that in the United Kingdom. JEL Classification: C32, E32, E51
    Keywords: Loan supply, business cycle, Euro area, UK, US, time-varying VAR, sign restrictions
    Date: 2012–09
  6. By: Nidhaleddine Ben Cheikh (CREM - Centre de Recherche en Economie et Management - CNRS : UMR6211 - Université de Rennes I - Université de Caen Basse-Normandie)
    Abstract: This paper examines the presence of nonlinear mechanism in the exchange rate pass-through (ERPT) to CPI inflation for 12 euro area (EA) countries. Using logistic smooth transition models, we explore the existence of nonlinearity with respect to economic activity along the business cycle. Our results provide a strong evidence of nonlinearity in 6 out of 12 EA countries with significant differences in the degree of ERPT between the periods of expansion and recession. However, we find no clear direction in this regime-dependence of pass-through to business cycle. In some countries, ERPT is higher during expansions than in recessions; however, in other countries, this result is reversed. These cross-country differences in the nonlinear mechanism of pass-through would have important implications for the design of monetary policy and the control of inflation in the EA context.
    Keywords: Exchange Rate Pass-Through; Inflation; Smooth Transition Regression
    Date: 2012–09–10
  7. By: Pedro Bação (Faculty of Economics, University of Coimbra and GEMF, Portugal); João Maia Domingues (Faculty of Economics, University of Coimbra, Portugal); António Portugal Duarte (Faculty of Economics, University of Coimbra and GEMF, Portugal)
    Abstract: This paper analyses the spread of the sovereign debt crisis in the Eurozone. To this end we employ three approaches. The first approach employs univariate autoregressive models. These allow the identification of shocks to government bond yields in Portugal, Italy, Ireland, Greece, Spain and Germany. The timing of the shocks is then analysed in search for evidence of a domino effect. The second approach applies the same identification procedure to VAR models estimated for each country. Finally, the third approach computes Granger causality tests between government bond yields in those countries. The results from the first two approaches do not appear to favor the contagion hypothesis. Nevertheless, the third approach, when bivariate VAR models are used, suggests that there may be interdependence between Greece, Ireland and Portugal, which might have justified European intervention to stop the crisis from spreading.
    Keywords: contagion; financial crisis; Granger causality; identification of shocks; sovereign debt crisis
    JEL: F36 E21 F32
    Date: 2012–08
  8. By: Elsner, Benjamin (IZA)
    Abstract: Around 9% of the Lithuanian workforce emigrated to Western Europe after the enlargement of the European Union in 2004. I exploit this emigration wave to study the effect of emigration on wages in the sending country. Using household data from Lithuania and work permit and census data from the UK and Ireland, I demonstrate that emigration had a significant positive effect on the wages of stayers. A one percentage-point increase in the emigration rate predicts a 0.67% increase in real wages. This effect, however, is only statistically significant for men.
    Keywords: emigration, labor mobility, EU enlargement
    JEL: F22 J61 R23
    Date: 2012–09
  9. By: Klára Bakk-Simon (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Stefano Borgioli (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Celestino Giron (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Hannah Sabine Hempell (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Angela Maddaloni (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Fabio Recine (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Simonetta Rosati (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main)
    Abstract: Shadow banking, as one of the main sources of financial stability concerns, is the subject of much international debate. In broad terms, shadow banking refers to activities related to credit intermediation and liquidity and maturity transformation that take place outside the regulated banking system. This paper presents a first investigation of the size and the structure of shadow banking within the euro area, using the statistical data sources available to the ECB/Eurosystem. Although overall shadow banking activity in the euro area is smaller than in the United States, it is significant, at least in some euro area countries. This is also broadly true for some of the components of shadow banking, particularly securitisation activity, money market funds and the repo markets. This paper also addresses the interconnection between the regulated and the non-bank-regulated segments of the financial sector. Over the recent past, this interconnection has increased, likely resulting in a higher risk of contagion across sectors and countries. Euro area banks now rely more on funding from the financial sector than in the past, in particular from other financial intermediaries (OFIs), which cover shadow banking entities, including securitisation vehicles. This source of funding is mainly shortterm and therefore more susceptible to runs and to the drying-up of liquidity. This finding confirms that macro-prudential authorities and supervisors should carefully monitor the growing interlinkages between the regulated banking sector and the shadow banking system. However, an in-depth assessment of the activities of shadow banking and of the interconnection with the regulated banking system would require further improvements in the availability of data and other sources of information. JEL Classification: G01, G15, G21, G28
    Keywords: Shadow banking, bank regulation, repo markets, securitisation
    Date: 2012–04
  10. By: Schmitt-Grohé, Stephanie; Uribe, Martín
    Abstract: Since the onset of the great recession in peripheral Europe, nominal hourly wages have not fallen much from the high levels they had reached during the boom years in spite of widespread increases in unemployment. This observation evokes a well-known narrative in which nominal downward wage rigidity is at the center of the current unemployment problem. We embed downward nominal wage rigidity into a small open economy with tradable and nontradable goods and a fixed exchange-rate regime. In this model, negative external shocks cause involuntary unemployment. We analyze a number of national and supranational policy options for alleviating the unemployment problem caused by the combination of downward nominal wage rigidity and a fixed exchange-rate regime. We argue that, in spite of the existence of a battery of domestic policies that could be effective in solving the unemployment problem, it is unlikely that a solution will come from within national borders. This leaves supranational monetary stimulus as the most compelling avenue out of the crisis. Our model predicts that full employment in peripheral Europe could be restored by raising the Euro-area annual rate of inflation to about 4 percent for the next five years.
    Keywords: currency pegs; downward wage rigidity; inflation; monetary union
    JEL: E31 E62 F41
    Date: 2012–09
  11. By: Ehrmann, Michael (European Central Bank, Frankfurt/Main, Germany); Soudan, Michel (European Central Bank, Frankfurt/Main, Germany); Stracca, Livio (European Central Bank, Frankfurt/Main, Germany)
    Abstract: We study the determinants of trust in the ECB as measured by the European Commission’s Eurobarometer survey in particular during the global financial crisis and the European sovereign debt crisis. We find that the fall in trust in the ECB in crisis times can be rather well explained based on the pre-crisis determinants, and show that the fall in trust reflected the macroeconomic deterioration, a more generalised fall in the trust in European institutions in the wake of the crisis as well as the severity of the banking sector’s problems, to which the ECB was associated in the public opinion.
    Keywords: Trust, Eurobarometer, Global financial crisis, Public opinion, European Central Bank
    JEL: E58 G21 Z13
    Date: 2012–08
  12. By: Fabian Eser (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Marta (Banco de España, C/Alcalá, 48, 28014 Madrid, Spain.); Stefano Iacobelli (Banca d’Italia, Via Nazionale, 91, 00184 Roma, Italy.); Marc Rubens (National Bank of Belgium, Boulevard de Berlaimont 14, 1000 Brussels, Belgium.)
    Abstract: This paper provides a comprehensive overview of the use of the Eurosystem’s monetary policy instruments and the operational framework from the first quarter of 2009 until the second quarter 2012. The paper discusses in detail, from a liquidity management perspective, the standard and non-standard monetary policy measures taken over this period. The paper reviews the evolution of the Eurosystem balance sheet, participation in tender operations, the outright purchase programmes, patterns of reserve fulfilment, recourse to standing facilities as well as the steering of money market interest rates. JEL Classification: D02, E43, E58, E65
    Keywords: Monetary policy implementation, central bank operational framework, central bank liquidity management, non-standard monetary policy measures
    Date: 2012–08
  13. By: Benedicta Marzinotto; André Sapir
    Abstract: The strengthening of the European Unionâ??s fiscal rules with the approval of the so-called â??six-packâ??, and the parallel worsening of economic conditions in Europe, re-opened the debate about the relationship between fiscal discipline and growth. Influential voices have argued against the EUâ??s perceived obsession with fiscal discipline, which risks being self-defeating in bad times. However, EU fiscal rules are not as rigid as commonly thought, but represent a sophisticated system of surveillance and ex-post control that provides sufficient room for manoeuvre under exceptional circumstances.
    Date: 2012–09
  14. By: Rossana Merola (OECD); Javier J. Pérez (Banco de España)
    Abstract: The fact that the literature tends to find optimistic biases in national fiscal projections has led to a growing recognition in the academic and policy arenas of the need for independent forecasts in the fiscal domain, prepared by independent agencies, such as the European Commission in the case of Europe. Against this background the aim of this paper is to test: (i) whether the forecasting performance of governments is indeed worse than that of international organizations, and (ii) whether fiscal projections prepared by international organizations are free from political economy distortions. The answer to these both questions is no: our results, based on real-time data for 15 European countries over the period 1999-2007, point to the rejection of the two hypotheses under scrutiny. We motivate the empirical analysis on the basis of a model in which an independent agency tries to minimize the distance to the government forecast. Starting from the assumption that the government’s information set includes private information not available to outside forecasters, we show how such a framework can help in understanding the observed empirical evidence
    Keywords: forecast errors, fi scal policies, fi scal forecasting, political economy
    JEL: H6 E62 C53
    Date: 2012–09
  15. By: Höring, Dirk
    Abstract: The European insurance industry is among the largest institutional investors in Europe. Therefore, major reallocations in their investment portfolios due to the new risk-based economic capital requirements introduced by Solvency II would cause significant disruptions in European capital markets and corporate financing. This paper studies whether the new regulatory capital requirements for market risk are a binding constraint for European insurers by comparing the market risk capital requirements of the Solvency II standard model with the Standard & Poor's rating model for a fictitious, but representative, European-based life insurer. The results show that for a comparable level of confidence, the rating model requires 68% more capital than the standard model for the same market risks. Hence, Solvency II seems not to be a binding capital constraint for market risk and thus would not significantly influence the insurance companies' investment strategies. --
    Keywords: Solvency II,Rating,Market Risk,Capital Requirements
    Date: 2012

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