nep-eec New Economics Papers
on European Economics
Issue of 2012‒12‒22
eighteen papers chosen by
Giuseppe Marotta
University of Modena and Reggio Emilia

  1. Euro at Risk: The Impact of Member Countries’ Credit Risk on the Stability of the Common Currency By Bekkour, Lamia; Jin, Xisong; Lehnert, Thorsten; Rasmouki, Fanou; Wolff, Christian C
  2. The Pricing of Sovereign Risk and Contagion during the European Sovereign Debt Crisis By Beirne, John; Fratzscher, Marcel
  3. "Conflicting Claims in the Eurozone? Austerity's Myopic Logic and the Need for a European Federal Union in a Post-Keynesian Eurozone Center-Periphery Model" By Alberto Botta
  4. Interest Rate Pass-Through in the Euro Area during the Financial Crisis: a Multivariate Regime-Switching Approach By David ARISTEI; Manuela Gallo
  5. Has the Euro changed the Business Cycle? By Enders, Zeno; Jung, Philip; Müller, Gernot
  6. What Drives Target2 Balances? Evidence From a Panel Analysis By Raphael Anton Auer
  7. Dollar funding and the lending behavior of global banks By Victoria Ivashina; David S. Scharfstein; Jeremy C. Stein
  8. Liquidity shocks, dollar funding costs, and the bank lending channel during the European sovereign crisis By Ricardo Correa; Horacio Sapriza; Andrei Zlate
  9. The German 'debt brake': A shining example for European fiscal policy? By Truger, Achim; Will, Henner
  10. Measuring Sovereign Contagion in Europe By Massimiliano Caporin; Loriana Pelizzon; Francesco Ravazzolo; Roberto Rigobon
  11. Adjustment Mechanisms in a Currency Area By Goodhart, Charles A; Lee, D J
  12. Evaluating Phillips curve based inflation forecasts in Europe: A note By Croonenbroeck, Carsten; Stadtmann, Georg
  13. Wage Inequality and Wage Mobility in Europe By Ronald Bachmann; Peggy Bechara; Sandra Schaffner
  14. Lessons of the financial crisis for the attractiveness of European financial centers By Lang, Gunnar
  15. Does corporate taxation affect cross-country firm leverage? By Antonio De Socio; Valentina Nigro
  16. An Analysis of Eurobonds By Beetsma, Roel; Mavromatis, Konstantinos
  17. GINI DP 42: Home-Ownership, Housing Regimes and Income Inequalities in Western Europe By Michelle Norris; Nessa Winston
  18. Global Value Chains and the EU Industry By Martin Borowiecki; Bernhard Dachs; Doris Hanzl-Weiss; Steffen Kinkel; Johannes Pöschl; Magdolna Sass; Thomas Christian Schmall; Robert Stehrer; Andrea Szalavetz

  1. By: Bekkour, Lamia; Jin, Xisong; Lehnert, Thorsten; Rasmouki, Fanou; Wolff, Christian C
    Abstract: In this paper, we empirically investigate the impact of the credit risk of Eurozone member countries on the stability of the Euro. In the absence of a common euro bond, euro-area credit risk is induced though the credit default swaps of the member countries. The stability of the euro is examined by decomposing dollar-euro exchange rate options into the moments of the risk-neutral distribution. We document that during the sovereign debt crisis changes in the creditworthiness of member countries have significant impact on the stability of the euro. In particular, an increase in member countries’ credit risk results in an increase of volatility of the dollar-euro exchange rate along with soaring tail risk induced through the risk-neutral kurtosis. We find that member countries’ credit risk is a major determinant of the euro crash risk as measured by the risk-neutral skewness. We propose a new indicator for currency stability by combining the risk-neutral moments into an aggregated risk measure and show that our results are robust to this change in measure. Noticeable is the fact that during the sovereign debt crisis, the creditworthiness of countries with vulnerable fiscal positions is the main risk-endangering factor of the euro-stability.
    Keywords: credit default swaps; currency options; currency stability; European sovereign debt crisis; risk-neutral distribution
    JEL: G1
    Date: 2012–11
  2. By: Beirne, John; Fratzscher, Marcel
    Abstract: The paper analyses the drivers of sovereign risk for 31 advanced and emerging economies during the European sovereign debt crisis. It shows that a deterioration in countries’ fundamentals and fundamentals contagion – a sharp rise in the sensitivity of financial markets to fundamentals – are the main explanations for the rise in sovereign yield spreads and CDS spreads during the crisis, not only for euro area countries but globally. By contrast, regional spillovers and contagion have been less important, including for euro area countries. The paper also finds evidence for herding contagion – sharp, simultaneous increases in sovereign yields across countries – but this contagion has been concentrated in time and among a few markets. Finally, empirical models with economic fundamentals generally do a poor job in explaining sovereign risk in the pre-crisis period for European economies, suggesting that the market pricing of sovereign risk may not have been fully reflecting fundamentals prior to the crisis.
    Keywords: bond spreads; CDS spreads; contagion; ratings; sovereign debt crisis; sovereign risk
    JEL: C23 E44 F30 G15 H63
    Date: 2012–12
  3. By: Alberto Botta
    Abstract: In this paper, we analyze the role of the current institutional setup of the eurozone in fostering the ongoing peripheral euro countries' sovereign debt crisis. In line with Modern Money Theory, we stress that the lack of a federal European government running anticyclical fiscal policy, the loss of euro member-states' monetary sovereignty, and the lack of a lender-of-last-resort central bank have significantly contributed to the generation, amplification, and protraction of the present crisis. In particular, we present a Post-Keynesian eurozone center-periphery model through which we show how, due to the incomplete nature of eurozone institutions with respect to a full-fledged federal union, diverging trends and conflicting claims have emerged between central and peripheral euro countries in the aftermath of the 2007-08 financial meltdown. We emphasize two points. (1) Diverging trends and conflicting claims among euro countries may represent decisive obstacles to the reform of the eurozone toward a complete federal entity. However, they may prove to be self-defeating in the long run should financial turbulences seriously deepen in large peripheral countries. (2) Austerity packages alone do not address the core problems of the eurozone. These packages would make sense only if they were included in a much wider reform agenda whose final purpose was the creation of a government banker and a federal European government that could run expansionary fiscal stances. In this sense, the unlimited bond-buying program recently launched by the European Central Bank is interpreted as a positive, albeit mild step in the right direction out of the extreme monetarism that has thus far shaped eurozone institutions.
    Keywords: Eurozone Debt Crisis; Modern Money Theory; Post-Keynesian Center-Periphery Model
    JEL: E02 E12 H63
    Date: 2012–12
  4. By: David ARISTEI; Manuela Gallo
    Abstract: In this paper we use a Markov-switching vector autoregressive model to analyse the interest rate pass-through between interbank and retail bank interest rates in the Euro area. Empirical results, based on monthly data for the period 2003-2011, show that during periods of financial distress bank lending rates to both households and non-financial corporations show a reduction of their degree of pass-through from the interbank rate. Interest rates on loans to non-financial firms are found to be more affected by changes in the interbank rate than loans to households, both in times of high volatility and in normal market conditions.
    Keywords: Interest rate pass-through, financial crisis, interbank interest rate; loans interest rate; Regime-switching vector autoregressive models; Euro area.
    JEL: C32 E43 E58 G01 G21
    Date: 2012–10–08
  5. By: Enders, Zeno; Jung, Philip; Müller, Gernot
    Abstract: In contrast to the notion that the exchange-rate regime is non-neutral, there is little evidence that EMU has systematically changed the European business cycle. In fact, we find the volatility of macroeconomic variables largely unchanged before and after the introduction of the euro. Exceptions are a strong decline in real exchange rate volatility and a considerable increase in cross-country correlations. To account for this finding, we develop a two-country business cycle model which is able to replicate key features of European data. In particular, the model correctly predicts a limited effect of EMU on standard business cycles statistics. However, further analysis reveals that the euro has changed the nature of the cycle through its impact on the transmission mechanism. Cross-country spillovers have become relatively more, domestic shocks relatively less important in accounting for economic fluctuations under EMU. This explains why there is little change in unconditional volatilities.
    Keywords: cross-country spillovers; EMU; euro; European business cycles; exchange rate regime; monetary policy; optimum currency area
    JEL: E32 F41 F42
    Date: 2012–11
  6. By: Raphael Anton Auer
    Abstract: What are the drivers of the large Target2 (T2) balances that have emerged in the European Monetary Union since the start of the financial crisis in 2007? This paper examines the extent to which the evolution of national T2 balances can be statistically associated with cross-border financial flows and current account (CA) balances. In a quarterly panel spanning the years 1999 to 2012 and twelve countries, it is shown that while the CA and the evolution of T2 balances were unrelated until the start of the 2007 financial crisis, since then, the relation between these two variables has become statistically significant and economically sizeable. This reflects the partial "sudden stop" to private sector capital that funded CA imbalances beforehand. I next examine how different types of financial flows have evolved over the last years and how this can be related to the evolution of T2 balances. While changes in cross-border positions in the interbank market are associated with increasing T2 imbalances, cross-border inter-office flows between banks belonging to the same financial institution have reduced T2 imbalances. Flows to the banking sector that originate from private investors and non-financial firms are large in magnitude, but are only weakly correlated with the evolution of T2 balances; changes in banks' holdings of foreign government debt and deposit flows are strongly correlated with the post-2007 evolution of T2 balances. Overall, these findings point to a sizeable transfer of risk from the private to the public sector within T2 creditor nations the via the use of central bank liquidity.
    Keywords: European Monetary Union, Euro, fiscal divergence, current account imbalances, TARGET2, central bank balance sheet, financial crisis, payment system
    JEL: E42 E58 F33 F32 F55 G14 G15
    Date: 2012
  7. By: Victoria Ivashina; David S. Scharfstein; Jeremy C. Stein
    Abstract: A large share of dollar-denominated lending is done by non-U.S. banks, particularly European banks. We present a model in which such banks cut dollar lending more than euro lending in response to a shock to their credit quality. Because these banks rely on wholesale dollar funding, while raising more of their euro funding through insured retail deposits, the shock leads to a greater withdrawal of dollar funding. Banks can borrow in euros and swap into dollars to make up for the dollar shortfall, but this may lead to violations of covered interest parity (CIP) when there is limited capital to take the other side of the swap trade. In this case, synthetic dollar borrowing becomes expensive, which causes cuts in dollar lending. We test the model in the context of the Eurozone sovereign crisis, which escalated in the second half of 2011 and resulted in U.S. money-market funds sharply reducing their funding to European banks. Coincident with the contraction in dollar funding, there were significant violations of euro-dollar CIP. Moreover, dollar lending by Eurozone banks fell relative to their euro lending in both the U.S. and Europe; this was not the case for U.S. global banks. Finally, European banks that were more reliant on money funds experienced bigger declines in dollar lending.
    Date: 2012
  8. By: Ricardo Correa; Horacio Sapriza; Andrei Zlate
    Abstract: This paper documents a new type of cross-border bank lending channel. The deepening of the European sovereign debt crisis in 2011 restrained the financial intermediation of European banks in the United States. In this period, some of the U.S. branches of European banks faced a dollar liquidity shock—due to their perceived risk reflecting the sovereign risk of their countries of origin—which in turn affected the branches’ lending to U.S. entities. We use a novel dataset to analyze the operations of branches of foreign banks in the United States. Our results show that: (1) The U.S. branches of European banks experienced a run on their deposits, mainly from U.S. money market funds. (2) The branches with curtailed access to large time deposits relied more on funding from their own parent institutions, thus shifting from being net suppliers to being net receivers of dollar funding from their related offices. (3) Since the additional funding received from parent institutions was not enough to offset the decreased access to U.S. funding, such branches reduced their lending to U.S. entities.
    Date: 2012
  9. By: Truger, Achim; Will, Henner
    Abstract: Many observers consider the German 'debt brake' beyond criticism. In the current crisis, many European countries have difficulties refinancing their budgets, while the German treasury's funding conditions are most favourable. The 'fiscal compact's' call for the introduction of German-style 'debt brakes' in the constitutions of other countries in order to rebuild their credibility on financial markets therefore might seem reasonable. However, there are several reasons to doubt the underlying (macro-) economic reasoning. Two specific problems of the German debt brake are analysed in greater detail: Firstly, the German rule is neither simple nor transparent. The calculation of structural deficits is a complex matter highly sensitive to specification and therefore open to political manipulation. Secondly, the debt brake will ultimately have a pro-cyclical effect because of the way the commonly used cyclical adjustment method works. This will, as a result, destabilise the economy. The German debt brake can therefore hardly serve as a good example for other countries. --
    Keywords: Germany,debt brake,Euro zone,Euro crisis,sovereign debt
    JEL: H12 H39 H50 H6
    Date: 2012
  10. By: Massimiliano Caporin; Loriana Pelizzon; Francesco Ravazzolo; Roberto Rigobon
    Abstract: This paper analyzes the sovereign risk contagion using credit default swaps (CDS) and bond premiums for the major eurozone countries. By emphasizing several econometric approaches (nonlinear regression, quantile regression and Bayesian quantile regression with heteroskedasticity) we show that propagation of shocks in Europe's CDS has been remarkably constant for the period 2008-2011 even though a significant part of the sample periphery countries have been extremely affected by their sovereign debt and fiscal situations. Thus, the integration among the different eurozone countries is stable, and the risk spillover among these countries is not affected by the size of the shock, implying that so far contagion has remained subdue. Results for the CDS sample are confirmed by examining bond spreads. However, the analysis of bond data shows that there is a change in the intensity of the propagation of shocks in the 2003-2006 pre-crisis period and the 2008-2011 post-Lehman one, but the coefficients actually go down, not up! All the increases in correlation we have witnessed over the last years come from larger shocks and the heteroskedasticity in the data, not from similar shocks propagated with higher intensity across Europe. This is the first paper, to our knowledge, where a Bayesian quantile regression approach is used to measure contagion. This methodology is particularly well-suited to deal with nonlinear and unstable transmission mechanisms.
    Keywords: Sovereign Risk, Contagion
    JEL: E58 F34 F36 G12 G15
    Date: 2012–12
  11. By: Goodhart, Charles A; Lee, D J
    Abstract: Both the euro-area and the United States suffered an initially quite similar housing and financial shock in 2007/8, with several states in both regions being particularly badly affected. Yet there was never any question that the worst hit US states would need a special bail-out or leave the dollar area, whereas such concerns have worsened in the euro-area. We focus on three badly affected states, Arizona, Spain and Latvia, to examine the working of relative adjustment mechanisms within the currency region. We concentrate on four such mechanisms, relative wage adjustment, migration, net fiscal flows and bank flows. Only in Latvia was there any relative wage adjustment. Intra-EU migration has increased, but is more costly for those involved in the EU (than in the USA). Net federal financing helped Arizona and Latvia in the crisis, but not Spain. The locally focussed structure of banking amplified the crisis in Spain, whereas the role of out-of-state banks eased adjustment in Arizona and Latvia. The latter reinforces the case for an EU banking union.
    Keywords: adjustment mechanisms; assymetric shocks; banking union; fiscal transfers; migration; relative unit labour costs
    JEL: F36 F40 J60 O52
    Date: 2012–11
  12. By: Croonenbroeck, Carsten; Stadtmann, Georg
    Abstract: We run out-of-sample forecasts for the inflation rate of 15 euro-zone countries using a NAIRU Phillips curve and a naïve reference model. Comparisons show that the naïve model returns better forecasts in almost all cases. We provide evidence that the Phillips curves' goodness of fit is rather high. However, forecasting power is comparatively low. --
    Keywords: Phillips Curve,Forecasting,Europe,RMSE
    JEL: C53 E31 E37
    Date: 2012
  13. By: Ronald Bachmann; Peggy Bechara; Sandra Schaffner
    Abstract: Using data from the European Union Statistics on Income and Living Conditions (EU-SILC), this paper investigates wage inequality and wage mobility in Europe. Decomposing inequality into within and between group inequality, we analyse to what extent wage inequality and mobility can be explained by observable characteristics. Furthermore, we investigate which individual and household characteristics determine transitions within the wage distribution. Finally, we examine the importance of institutions for wage inequality, wage mobility, and wage transitions. We find that overall, mobility reduces wage inequality. While a large part of wage inequality is due to unobservable characteristics, the equalizing effect of mobility mainly occurs within groups. Furthermore, both personal and household characteristics play an important role for wage transitions. Finally, our findings reveal large cross-country differences across Europe, which are partly linked to the institutional set-up of the national labour markets.
    Keywords: Wage inequality; wage mobility; wage transitions; cross-country analysis
    JEL: J6 J31 P52
    Date: 2012–12
  14. By: Lang, Gunnar
    Abstract: This paper analyses fundamental location factors for the financial industry by investigating the economic significance of market participants' assessments of location factors and country-specific characteristics over time. A unique data set allows studying the locational attractiveness of financial centers before, during, and after the recent financial crisis. The results reveal that especially dense networks in cluster concentration and governmental support strongly determine a location's attractiveness for financial institutions, whereas a specialized pool of labor alone without concentration and the level of taxation seem not to be relevant. Financial centers with a strong home market benefit during times of crisis in contrast to offshore centers and vice versa. Overall, financial centers' attractiveness varies over time, while the decisive location factors stay the same. The findings are not hinged by differences in market participants' socio-economic backgrounds. Investment fund companies seem to value the attractiveness of a financial center much more than banks, insurance companies, and corporates do. --
    Keywords: Financial Crisis,Financial Center,Government Policy
    JEL: G01 G20 G28 D22
    Date: 2012
  15. By: Antonio De Socio (Bank of Italy); Valentina Nigro (Bank of Italy)
    Abstract: We evaluate the relation between firm leverage and taxation of corporate income using a dataset of mostly unlisted European corporations, highly representative of medium-sized and large firms. We use a correlated random effect approach in order to take into account unobserved heterogeneity and to assess the contribution of cross-sectional variation of the regressors. We also apply quantile regressions to evaluate a possible differential impact of taxation on leverage across firms. Our results suggest that corporate income taxation is positively related to leverage and explains part of the cross-country variability, showing a stronger effect for less levered firms. In accordance with the theory of the debt tax shield, the relation between debt and taxation is stronger for highly profitable firms. These findings are robust to the inclusion of different measures of the financial development and characteristics of the legal system of the country where firms are located.
    Keywords: leverage, corporate taxation, financial structure
    JEL: G32 H32
    Date: 2012–11
  16. By: Beetsma, Roel; Mavromatis, Konstantinos
    Abstract: We analyse different forms of international debt mutualisation in a simple framework with a political distortion and (partial) default under adverse economic circumstances. One form is a debt repayment guarantee, which can be "unlimited" or "limited", i.e. only be invoked when the guarantee threshold is not exceeded. We also explore the "blue-red" bonds proposal, under which blue debt is guaranteed by the other countries in a union, while red debt is not guaranteed. Only a suitably chosen limited guarantee induces the government to reduce debt and raises social welfare. Making the guarantee also conditional on sufficient structural reform may stimulate reform effort. However, now a trade-off exists between extracting more reform and inducing the government to limit debt issuance.
    Keywords: blue and red bonds; debt bias; debt guarantee; eurobonds; political distortions; social welfare; structural reform
    JEL: E60 E62 H60 H63
    Date: 2012–12
  17. By: Michelle Norris (Extension at the Champaign Center, University of Illinois); Nessa Winston
    Abstract: This article compares the structural features of home-ownership systems in EU15 countries (home-ownership rates, mortgages and public subsidisation of this tenure) with data on inequalities in outcomes (variations in home-ownership access, risks and standards between income groups). Its purpose is to assess the relevance of the debate on the convergence and divergence of housing systems which has dominated the comparative housing literature. The article concludes that, depending on the level of analysis adopted and the particular variables selected for examination, elements of both convergence and divergence are evident in Western European home-ownership systems. The comparative housing literature has also largely failed to capture the key inter-country cleavages in home-ownership systems that are between the Northern and Southern EU15 countries. These shortcomings are related to methodological and conceptual problems in this literature.
    Date: 2012–07
  18. By: Martin Borowiecki; Bernhard Dachs; Doris Hanzl-Weiss (The Vienna Institute for International Economic Studies, wiiw); Steffen Kinkel; Johannes Pöschl (The Vienna Institute for International Economic Studies, wiiw); Magdolna Sass; Thomas Christian Schmall; Robert Stehrer (The Vienna Institute for International Economic Studies, wiiw); Andrea Szalavetz
    Abstract: (Report based on Background Study for European Competitiveness Report 2012, see http // ongoing internationalization of production has altered the economic landscape. Many products used to be produced locally using inputs drawn largely from the domestic economy, which implied that most of the value chains or production processes used to be located in the country where a firm had its headquarters. Technological development has facilitated the geographical fragmentation of production processes, resulting in the emergence of global value chains. Different parts of a firm’s production processes can now be located in different parts of the world, according to the comparative advantages of the locations. This ‘slicing up of the value chains’, and the dispersal of the various elements to different parts of the world has given rise to increased trade with the use of imported intermediate goods in manufacturing industries having been increased globally, thereby involving more industries and countries in the value chains. Focusing on four important manufacturing industries (chemicals, chemical products and man-made fibres; machinery and equipment; electrical and optical equipment; and transport equipment) the ongoing trends of the internationalization of production is studied. To account for the multi-faceted phenomenon of the internationalization of production processes and its consequences, a comprehensive review of the literature is provided first. This is followed by an overview of the patterns and trends in vertical specialization across countries for the four selected industries. This section is based on the World Input-Output Database (WIOD), which allows the integration of production patterns and processes to be studied at a global level. As this is accompanied by similar trends in trade before and over the crisis the next section focuses on the changes in trade patterns of these industries which is based on detailed Harmonized System (HS) 6-digit trade data allowing for a differentiation between use categories of products trade in parts and components is important for the machinery and equipment, electrical and optical equipment and transport equipment industries, while trade in semi-finished products is important for the chemicals industry. As the offshoring decisions are made at company level it is important to understand the motives leading firms to offshore, the drivers of the decisions with respect to characteristics of the host and the destination country and the characteristics of the offshoring firms. Section 5 therefore focuses on the offshoring decisions at the company level it analyses the motives and determinants of company strategies with respect to the relocation of production. Section 6 provides a summary.
    Keywords: vertical integration, trade in intermediates, offshoring
    JEL: F1 F15 F19
    Date: 2012–10

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