nep-eec New Economics Papers
on European Economics
Issue of 2013‒03‒16
nineteen papers chosen by
Giuseppe Marotta
University of Modena and Reggio Emilia

  1. Towards a New EMU By Fritz Breuss
  2. A new approach of contagion based on smooth transition conditional correlation GARCH models: An empirical application to the Greek crisis By Henri Audigé
  3. The fundamentals of sovereign debt sustainability: Evidence from 15 OECD countries. By Christian Schoder
  4. Ageing and fiscal sustainability in a small euro area economy By Gabriela Lopes de Castro; José R. Maria; Ricardo Mourinho Félix; Cláudia Braz
  5. What Drives Target2 Balances? Evidence From a Panel Analysis By Raphael A. Auer
  6. The challenges of EU governance and the quest for long-term growth By Renaud Thillaye
  7. Slovakia: A Catching Up Euro Area Member In and Out of the Crisis By Fidrmuc, Jarko; Klein, Caroline; Price, Robert; Wörgötter, Andreas
  8. The EU’s Multi-Annual Financial Framework for 2014-2020: an Old Construct Fit for a Changed EU? By Sándor Richter
  9. The Interconnections Between the Shadow Banking System and the Regular Banking System. Evidence from the Euro Area By Jeffers, E.; Baicu, C.
  10. Interest rate volatility: a consol rate-based measure By Vincent Brousseau; Alain Durré
  11. The Impact of Market Regulations on Intra-European Real Exchange Rates By Agnès Bénassy-Quéré; Dramane Coulibaly
  12. Fiscal Policy Stance in the European Union: The Impact of the Euro By Mencinger, Jernej; Aristovnik, Aleksander
  13. The impact of yuan internationalization on the euro-dollar exchange rate. By Agnès Bénassy-Quéré; Yeganeh Forouheshfar
  14. Capital Prices and Eurozone Competitiveness Differentials By Askenazy, Philippe
  15. we need fiscal rules ?. By Mathieu, Catherine; Sterdyniak, Henri
  16. Interest Rate Expectations in the Media and Central Bank Communication By Michael J. Lamla; Jan-Egbert Sturm
  17. The Eurozone: Piecemeal Approach to an Optimum Currency Area By Heinz Handler
  18. zone euro en crise : introduction. By Mathieu, Catherine; Sterdyniak, Henri
  19. Can Europe recover without credit? By Zsolt Darvas

  1. By: Fritz Breuss (WIFO)
    Abstract: The global financial and economic crisis in 2008-09 followed by a "Euro crisis" – not a crisis of the Euro but a sovereign debt (and/or banking) crisis in some Euro countries – forced to reforms of the asymmetric policy design of the Economic and Monetary Union (EMU). Starting with ad-hoc rescue operations for Greece, Ireland and Portugal a whole bunch of reform steps were necessary to make the Euro area "crisis-proof" for the future. Whether the measures taken are already enough to make the EMU better functioning in future crises is an open question. Nevertheless, the crisis proved to act like Schumpeter's "process of creative destruction": the old (not crisis-proof) institutional set-up has been gradually changed towards a more centralised fiscal policy at EU/Euro area level within a new EMU economic governance. Besides the improvement of the policy instruments of the "Economic Union" of EMU, also the ECB with its monetary policy entered more and more into the role of a lender of last resort of the banking sector. More far-reaching plans (that of Barroso and of Van Rompuy) are already on the table which should transform the European Union from a "Fiscal and Transfer Union" over a "Banking Union" into a genuine EMU with the final goal of a "Political Union", not to mention the "United States of Europe" (USE).
    Keywords: Economic and Monetary Union, Eurozone, European Integration, EU
    Date: 2012–03–06
  2. By: Henri Audigé
    Abstract: The objective of this paper is to gauge how and to which extent the surge in Greek sovereign bond rates in 2010 and 2011 has spilled over the rest of the Euro-area. To this end, we rely on a new class of contagion tests based on Smooth Transition Conditional Correlation GARCH models (STCC-GARCH). Our results highlight the existence of contagion and “wake-up call” effects from Greece to Ireland and Portugal in 2010, and a decoupling in the correlations between Greece and other peripheral countries in 2011. Regarding the core countries, our findings suggest flight-to-quality effects from Greece to Germany and the Netherlands.
    Keywords: Bond market, contagion, European crisis, multivariate GARCH models
    JEL: C32 C58 G01 G12
    Date: 2013
  3. By: Christian Schoder
    Abstract: We study the sustainability of sovereign debt accumulation in 15 OECD countries using quarterly data from 1980 to 2010 with a focus on how and in what countries debt sustainability changed after the commencement of the Euro Convergence Criteria in 1997 as well as after the financial meltdown in 2007. We define sustainability as the validity of the inter-temporal budget constraint of the government and test a sufficient condition motivated by Bohn (1998) using single-country and pooled regressions. We find evidence that the Euro Convergence Criteria contributed to the sustainability of debt accumulation. Further, while the yield spreads suggest the debt crisis is a problem of the southern Euro countries, we find a lack of debt sustainability for Greece, Portugal and France but not for Italy and Spain. In terms of debt sustainability, the crisis adversely affected primarily stand-alone countries rather than members of the European Monetary Union. Nevertheless, yield spreads increased more in the southern countries of the monetary union than in stand-alone countries. Our results support the view that countries within a monetary union are more prone to investors' sentiments than stand-alone countries.
    Keywords: sovereign debt, sustainability, debt crisis, bounds testing approach, pooled mean-group estimator
    JEL: H62 H63 E60
    Date: 2013
  4. By: Gabriela Lopes de Castro; José R. Maria; Ricardo Mourinho Félix; Cláudia Braz
    Abstract: Population ageing is a key trend in Western economies. The impact of this trend will be widespread, affecting investment and saving decisions over the next decades, and represents a major challenge to policymakers. Debt sustainability issues in euro area economies may (re)emerge, particularly given the pay-as-you-go nature of most public pension systems. In a decentralised fiscal policy framework, ageing and the respective policy response might intensify the latent macroeconomic imbalances that underlie the ongoing sovereign debt crisis. In this paper, we include a stylised pension system in an open economy New-Keynesian general equilibrium model with non-Ricardian agents. The model is used to assess the macroeconomic impacts of ageing in a small euro area economy. The results suggest that the impact can be significant, depending on the magnitude and pace of the ageing dynamics, the existing rules for social benefits and the policy response. It can be inferred from the results that supranational policy coordination at euro area level is crucial to foster economic and financial stability.
    JEL: E62 F41 H62 J11
    Date: 2013
  5. By: Raphael A. Auer (Swiss National Bank)
    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 private capital 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 “sudden stop” to private sector capital that funded CA imbalances beforehand. I next examine how different types of private capital flows have evolved over the last years and how this can be related to the evolution of T2 balances, finding some deposit flight by private customers, a substantial retrenchment of cross-border interbank lending, and also an increase of bank’s holdings of high-quality sovereign debt. My first conclusion from this analysis is that since T2 imbalances were caused by a sudden stop and are unlikely to grow without bounds since Euro area CA imbalances are currently diminishing at a rapid pace, there is no evidence that the institutional setup of the European Monetary Union needs to be reformed fundamentally. My second conclusion relates to how the current system transfers risks across the currency union, both in terms of risk transfer from T2 debtor to T2 creditor nations and in terms of risk transfer from the private sector to the public sector within T2 creditor nations. I evaluate existing reform proposals in the light of these risk transfers.
    Date: 2013–03
  6. By: Renaud Thillaye
    Abstract: The research paper assesses the opportunities and challenges raised by the post-crisis EU governance system with regard to the transition of European economies towards a new growth model balancing economic performance with social cohesion and environmental responsibility. It begins with questioning the term of ‘governance’ and with a hint at the 'multi-level governance' literature available in EU studies. This section suggests that the EU's nature is one of multiple and innovative policymaking methods. Any assessment of the EU's added value must investigate the actual policy direction and the effectiveness of a complex EU governance architecture, by looking in particular at how EMU coordination frameworks interacts with Community-based policies. The paper focuses then on the goals, the processes and the financial instruments underpinning the Europe 2020 Strategy, bearing in mind the limits encountered by the Lisbon Strategy during the last decade. It finds that the Strategy, albeit carefully balanced, does not avoid the risk of a 'capability-expectations' gap. Implementation would gain, on the one side, from more consistent legal and financial instruments at EU level, and from a more supportive macroeconomic environment in the euro area on the other. The third section examines the way in which Europe 2020 cohabits with other frameworks of coordination within the European Semester, such as the reformed Stability and Growth Pact, and the new Macroeconomic Imbalance Procedure. Potential clashes between diverging objectives and their legal bases are identified and tested against the views of practitioners (8 interviews were conducted in parallel to the research) and throughout a case-study based on how the Semester has so far impacted on three countries: Finland, France and Italy. The European Commission's Annual Growth Surveys for 2011, 2012 and 2013 are also analysed. This research reveals a prioritisation of fiscal consolidation and short-term, market-based adjustment policies over the longer-term objectives pursued by the Europe 2020 Strategy. The collective outcome of these policies, and the impact of national reforms on the whole EU, tend to be overlooked as well. Nevertheless, there is substantial room for manoeuvre and dialogue between the Commission and individual countries. The paper concludes that ways should be found to shield Europe 2020 objectives from overwhelming stability considerations in the Euro Area, and contains some suggestions for further innovations of governance in that respect. A greater differentiation between countries according to their position might be necessary. The conclusion also argues that it fells to national governments, parliaments and parties to seize the opportunity of the European Semester to frame challenges differently and to push for alternative solutions.
    Keywords: Economic strategy; EU integration; European economic policy; European governance; European Monetary Union; Good governance; Institutional reforms
    JEL: E02
    Date: 2013–02
  7. By: Fidrmuc, Jarko (Zeppelin University); Klein, Caroline (OECD); Price, Robert (affiliation not available); Wörgötter, Andreas (OECD, Paris)
    Abstract: The Slovak economy experienced a strong but short recession in 2009. The recovery afterwards was driven by exports and investment. While GDP growth was one of the strongest in OECD, employment did not reach the pre-crisis level and unemployment remains stubbornly high. This paper argues that Slovakia joined the euro area after a period of unprecedented real appreciation, which generated a threat for competitiveness of its export-oriented manufacturing industry. The response combined internal devaluation with productivity increasing measures, including capital deepening and laying off low productivity workers. While this strategy was successfully restoring an external equilibrium, its consequences for domestic demand and employment are less positive. This development is compared with Estonia and Slovenia, two other small and very open economies, recently entering the euro area.
    Keywords: Slovak Republic, Estonia, Slovenia, crisis, job-less recovery, domestic demand
    JEL: E20 F41 G01
    Date: 2013–03
  8. By: Sándor Richter
    Abstract: As a consequence of the 2008-2009 international financial crisis the European Union is undergoing per-haps its most difficult period since the beginnings of the European integration. The response to this challenge includes decisions and planned steps to strengthen fiscal discipline in the member states, safeguard measures against a falling-apart of the eurozone and the introduction of a Union-wide super-vision of the European banking sector. A new fiscal capacity (budget) for the eurozone is under consid-eration. It seems that the extraordinary situation has triggered a wave of extraordinary reforms throughout the EU. In one area, the Community Budget, however, time seems to have stopped temporarily. The European Council of 22-23 November 2012 was unable to arrive at a compromise on the terms of the Multi-annual Financial Framework (MFF or the EU budget) and postponed the decision to 7-8 February. The contradiction between the decades-old unsolved budgetary problems and the rapidly changing environment cannot be greater as it is now.
    Keywords: European Union, Multiannual Financial Framework,  EU budget, net financial position, Cohesion Policy, CAP, Europe 2020,
    JEL: F36
    Date: 2013–02
  9. By: Jeffers, E.; Baicu, C.
    Abstract: One of the most important lessons of the global financial crisis has been the deep interconnectedness between the shadow banking system and the regular banking system. These two systems are linked through several channels, of which one of the most important is the financing provided by regular banks to the shadow banking system and vice versa. In addition, regular banks can originate loans that are securitized. Subsequently, part of the securitized instruments may remain on the balance sheet of the originating banks or be found on the balance sheet of other regular banks and shadow banking entities. These links between the two systems can increase contagion and systemic risks, which in turn may affect financial stability. The financial crisis has acutely revealed the negative effects these interconnections can generate. The interconnections are underestimated by the available data because of the difficulties in gathering information on the euro area. Within this context, our paper tries to evaluate and analyze the interconnections between the shadow banking system and the regular banking system within the euro area, both in the pre-crisis period and currently. Finally, some measures to regulate the interconnections between these two systems are raised.
    Keywords: shadow banking; traditional banking; the European banking system
    Date: 2013
  10. By: Vincent Brousseau (European Central Bank); Alain Durré (European Central Bank; IESEG - School of Management; Lille Economie & Management)
    Abstract: In this paper we propose a new methodology to estimate the volatility of interest rates in the euro area money market. In particular, our approach aims at avoiding the limitations of currently available measures, i.e. the dependency on arbitrary choices in terms of maturity and frequencies and/or of factors other than pure interest rates, e.g. credit risk or liquidity risk. The measure is constructed as the implied instantaneous volatility of a consol bond that would be priced on the EONIA swap curve over the sample period from 4 January 1999 to 20 November 2012. We show that this measure tracks well the historical volatility, in the sense that dividing the consol excess returns by this volatility removes nearly entirely excess of kurtosis and volatility clustering, bringing them close to an ordinary Gaussian white noise. JEL Classification: E43, E58, C22, C32
    Keywords: consol rate, historical volatility, overnight money market, interbank o¤ered interest rates
    Date: 2013–01
  11. By: Agnès Bénassy-Quéré; Dramane Coulibaly
    Abstract: We study the contribution of market regulations in the dynamics of the real exchange rate within the European Union. Based on a model proposed by De Gregorio et al. (1994a), we show that both product market regulations in nontradable sectors and employment protection tend to inflate the real exchange rate. We then carry out an econometric estimation for European countries over 1985-2006 to quantify the contributions of the pure Balassa-Samuelson effect and those of market regulations in real exchange-rate variations. Based on this evidence and on a counter-factual experiment, we conclude that the relative evolution of product market regulations and employment protection across countries play a very significant role in real exchange- rate variations within the European Union and especially within the Euro area, through theirs impacts on the relative price of nontradable goods.
    Keywords: Real exchange rate, Balassa-Samuelson effect, Product market regulations, Employment protection
    JEL: F41 J50 L40
    Date: 2013
  12. By: Mencinger, Jernej; Aristovnik, Aleksander
    Abstract: In the recent years there has been an intense discussion whether the actual behaviour of fiscal authorities is consistent with cyclical stabilization objectives. The question of the appropriate fiscal policy is gaining recognition especially for the countries of the euro area after entering the European Monetary Union (EMU). Therefore, the aim of this paper is to evaluate the activity of the fiscal policy before and after the entrance to the euro zone for each individual EMU country in 1995–2010 period. For this purpose we will use the cyclical adjusted balance, which is the common tool used to estimate fiscal policy stance. The analysis of the cyclically adjusted balance gives an additional insight into the former activity arrangements of the fiscal policy, which contributes to gauge the ex-post estimation of the fiscal policy. On this base we can determine the causes of general government budgets imbalance in the past. Despite this fact, we should be aware of some caveats in the assessment of cyclical adjusted balance, which appear due the inconsistency in measurement of output gap and potential GDP growth. To evaluate pro-cyclical or countercyclical fiscal policy stance we compare the dynamic evaluation of the cyclically adjusted balance and output gap. Namely, changes of the cyclically adjusted balance in consecutive years indicate the orientation of fiscal policy, i.e. the fiscal impulse. By comparing the change in the cyclically adjusted balance and output gap between individual years, which indicates fluctuations in the economic cycle, it is possible to assess the orientation of fiscal policy, i.e. the fiscal position. The fiscal policy can be considered as countercyclical if it is expansive in the situation of negative output gap and restrictive in the situation, when the actual growth of GDP is above its potential rate. On the other hand, fiscal policy is characterized to be pro-cyclical if in the situation of negative output gap the government uses restrictive fiscal instruments and when the fiscal policy reacts expansionary in the situation of positive output gap, where the actual output exceeds the estimated potential GDP. In the empirical analysis we evaluate the fiscal policy stance for each country of the euro area. In the assessment of government behaviour we cover 14 countries in the 1995–2010 period. The results of the analysis generally confirm that the fiscal policy in most euro-area member states became more expansionary in the period after entering the EMU. Moreover, these preliminary findings were partly confirmed by a statistical analysis which shows statistically significant differences in expansionary fiscal policy between the aforementioned sub-periods. In addition, we might also conclude the average fiscal stance is expansionary when actual output is above its potential level, which implies a pro-cyclical bias in times of prosperity, and that the fiscal stance tends to be predominantly counter-cyclical when actual output is below its potential level. These conclusions can be associated with asymmetric fiscal behaviour after entering the euro area because the response of fiscal authorities to cyclical conditions in the economy depends on whether good or bad times are prevailing. These assertions reflect some conclusions made in other similar studies.
    Keywords: fiscal policy, fiscal policy stance, cyclically adjusted balance, output gap, SGP, EMU
    JEL: E62 E65 F36 H30
    Date: 2013–02
  13. By: Agnès Bénassy-Quéré (Centre d'Economie de la Sorbonne - Paris School of Economics et CESIfo); Yeganeh Forouheshfar (Université Paris-Dauphine)
    Abstract: We study the implication of a multipolarization of the international monetary system on cross-currency volatility. More specifically, we analyze whether the internationalization of the yuan could modify the impact of asset supply and trade shocks on the euro-dollar exchange rate, within a three-country, three-currency portfolio model. Our static model shows that the internationalization of the yuan (defined as a rise in the yuan in international portfolios) would be either neutral or stabilizing for the euro-dollar rate, whatever the exchange-rate regime of China. Moving to a dynamic, stock-flow framework, we show that the internationalization of the yuan would make exchange-rate variations more efficient to stabilize net foreign asset positions after a trade shock.
    Keywords: China, yuan, exchange-rate regime, euro, dollar.
    JEL: F31 F33
    Date: 2013–02
  14. By: Askenazy, Philippe (Paris School of Economics)
    Abstract: Competitiveness differentials are blamed for the instability of the Eurozone. Most of the analyses focus on labour costs or labour-market institutions. This paper explores an additional source of differentials in competitiveness: land and building prices. European countries, especially France, have experienced a significant rise in property prices since the beginning of the century. Germany is an exception. A large increase in the prices of buildings, structures and lands for private companies can be also observed in some countries. Higher prices impede firm competitiveness in at least two ways: a) investments are more costly; b) the increasing value of non‐financial assets should translate into higher equity value and thus incite firms to increase dividends so as to preserve firm owners' direct remuneration. French national accounts provide rich information for exploring these mechanisms. We show that the nominal value of buildings, structures and land owned by non‐financial corporations dramatically increased relative to their value added, well above their historical observations. We argue that, in France, non‐financial corporations (NFCs) pay a large supplementary cost for their investments and have to distribute massive additional dividends. The yearly charge counts for at least 4% of their value added.
    Keywords: Eurozone, competitiveness, non‐financial asset prices, housing bubble
    JEL: E22 E31 J30
    Date: 2013–02
  15. By: Mathieu, Catherine (OFCE); Sterdyniak, Henri (OFCE)
    Abstract: The public finances crisis has brought binding fiscal rules proposals back to the forefront. The paper analyses their justifications and specifications, either in a classical or in a Keynesian framework. In the recent period there is no evidence that public deficits were caused by fiscal indiscipline and induced too high interest rates; there is no evidence that economically relevant rules can be designed. The paper provides an analysis of fiscal rules implemented either at country level (like the UK golden rule), or at the EU level (the Stability and Growth Pact). The paper shows that fiscal rules did not work before and during the crisis. The paper discusses the EU project, the “Fiscal Pact”, which risks to paralyse fiscal policies and to prevent economic stabilisation. The priority today is not to strengthen public finance discipline but to question economic developments which make public deficits necessary to support output.
    Date: 2013–01
  16. By: Michael J. Lamla (KOF Swiss Economic Institute, ETH Zurich, Switzerland); Jan-Egbert Sturm (KOF Swiss Economic Institute, ETH Zurich, Switzerland)
    Abstract: While there is ample evidence how central bank communication and interest rate decisions are perceived by financial markets, insights regarding the response of the public is lacking. Media is known to be an important transmitter of news to the public. Based on articles in the Financial Times Europe, we test how expectations on the future course of monetary policy presented in the media are affected by central bank communication and interest rate decisions.
    Keywords: European Central Bank, monetary policy announcements, central bank communication, media expectations
    JEL: E52 E58
    Date: 2013–03
  17. By: Heinz Handler (WIFO)
    Abstract: Soon after the establishment of the Eurozone it became obvious that the structural differences between member countries would not abate, as expected, but rather gradually widen. Although part of the problem can be attributed to the enlargement process, it also relates to asymmetric effects of the common currency and to diverging economic policies. This paper discusses the literature which associates the economic characteristics of EMU with arguments of the optimum currency area (OCA) theory and asks for missing capstones that would meliorate EMU to eventually resemble an OCA. As potential candidates for such building blocks, some sort of fiscal union and lender of last resort may qualify, drawing on the experiences of other currency unions and federal states. The financial and debt crisis has revealed that the endogenous forces within a currency union may be too slow to absorb the shocks originating from the crisis. For a currency union to survive in such a situation it is all the more important that the OCA criteria are met and/or that complementary institutions are in place. However, as actual developments in the Eurozone reveal, the political process of approaching an OCA is piecemeal rather than comprehensive and prompt.
    Date: 2013–02–25
  18. By: Mathieu, Catherine; Sterdyniak, Henri (OFCE)
    Abstract: Introduction du numéro spécial de la Revue de l'Ofce consacré à "La zone Euro en crise".
    Date: 2013–01
  19. By: Zsolt Darvas
    Abstract: â?¢ Data from 135 countries covering five decades suggests that creditless recoveries, in which the stock of real credit does not return to the pre-crisis level for three years after the GDP trough, are not rare and are characterised by remarkable real GDP growth rates: 4.7 percent per year in middle-income countries and 3.2 percent per year in high-income countries. â?¢ However, the implications of these historical episodes for the current European situation are limited, for two main reasons: â?¢ First, creditless recoveries are much less common in high-income countries, than in low-income countries which are financially undeveloped. European economies heavily depend on bank loans and research suggests that loan supply played a major role in the recent weak credit performance of Europe. There are reasons to believe that, despite various efforts, normal lending has not yet been restored. Limited loan supply could be disruptive for the European economic recovery and there has been only a minor substitution of bank loans with debt securities. â?¢ Second, creditless recoveries were associated with significant real exchange rate depreciation, which has hardly occurred so far in most of Europe. This stylised fact suggests that it might be difficult to re-establish economic growth in the absence of sizeable real exchange rate depreciation, if credit growth does not return.
    Date: 2013–02

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