nep-eec New Economics Papers
on European Economics
Issue of 2013‒09‒24
thirteen papers chosen by
Giuseppe Marotta
University of Modena and Reggio Emilia

  1. Macro-Financial Implications of Corporate (De)Leveraging in the Euro Area Periphery By Manuela Goretti; Marcos Souto
  2. How the Euro Crisis Evolved and How to Avoid Another: EMU, Fiscal Policy and Credit Ratings By Polito, Vito; Wickens, Michael R.
  3. The "Greatest" Carry Trade Ever? Understanding Eurozone Bank Risks By Acharya, Viral V; Steffen, Sascha
  4. Intraday dynamics of euro area sovereign CDS and bonds By Jacob Gyntelberg; Peter Hördahl; Kristyna Ters; Jörg Urban
  5. The Driving Force behind the Boom and Bust in Construction in Europe By Yan Sun; Pritha Mitra; Alejandro Simone
  7. Convergence in European retail payments By Martikainen, Emmi; Schmiedel, Heiko; Takalo, Tuomas
  8. Eurozone Sovereign Yield Spreads and Diverging Economic Fundamentals By Beber, Alessandro; Brandt, Michael; Luisi, Maurizio
  9. Towards deeper financial integration in Europe: What the Banking Union can contribute By Buch, Claudia M.; Körner, Tobias; Weigert, Benjamin
  10. Structural or Cyclical? Unemployment in Latvia Since the 2008-09 Financial Crisis By Anosova, Daria; Sonin, Konstantin; Vanags, Alf; Zasova, Anna
  11. Can fiscal austerity be expansionary in present Europe? The lessons from Sweden By Erixon, Lennart
  12. The Portuguese Slump and Crash and the Euro Crisis By Reis, Ricardo
  13. Trends and convergence of Europe’s minimum income schemes By Natascha Van Mechelen; Sarah Marchal

  1. By: Manuela Goretti; Marcos Souto
    Abstract: High corporate indebtedness can pose an important threat to the adjustment processes in some of the Euro area periphery countries, through its drag on investment as well as the possible migration of private sector losses to the sovereign balance sheet. This paper examines the macroeconomic implications of corporate debt overhang in recent years, confirming empirical evidence in the literature on the relationship between a firm’s balance sheet position and its investment choices, especially beyond certain threshold levels. Building on an event study of past crisis experiences with corporate deleveraging, it also discusses the expected macro-financial impact of the ongoing deleveraging processes in these countries, presenting available policy options to facilitate an orderly balance-sheet adjustment and support a return to productivity and growth.
    Keywords: Corporate sector;Europe;Debt burden;Euro Area;Financial crisis;Debt restructuring;Corporate Investment, Debt overhang, Deleveraging, Crisis, Euro Area
    Date: 2013–06–26
  2. By: Polito, Vito; Wickens, Michael R.
    Abstract: This paper argues that the crisis was an outcome of EMU: setting a common monetary policy for countries with different initial inflation rates. The crisis countries were those with high inflation rates which then had negative real interest rates and consequently over-borrowed. Current policy discussions focus on crisis measures: fiscal, banking and political union, not avoiding another crisis. This paper suggests two ways to avoid a future crisis: offset an inappropriate monetary policy using fiscal policy; markets could better price loan rates by taking into account default risk. The paper shows that neither was done prior to the crisis.
    Keywords: credit ratings; EMU; euro crisis; fiscal policy
    JEL: E52 E62 H63 H68
    Date: 2013–06
  3. By: Acharya, Viral V; Steffen, Sascha
    Abstract: This paper argues that the European banking crisis can in part be explained by a “carry trade” behavior of banks. Factor loading estimates from multifactor models relating equity returns to GIPSI (Greece, Ireland, Portugal, Spain and Italy) and German government bond returns suggest that banks have been long peripheral sovereign bonds funded in short-term wholesale markets, a position that generated “carry” until the GIPSI bond returns deteriorated significantly inflicting significant losses on banks. We show that the positive GIPSI factor loadings reflect actual portfolio holdings of GIPSI bonds in the cross-section of banks; and, the negative German loading reflects funding risk (flight away from bank funding to German government bonds), a risk that is increasing in the US money market mutual fund exposures of European banks as well as various proxies for bank short-term debt. Large banks and banks with low Tier 1 ratios and high risk-weighted assets had particularly large exposures and even increased their exposures between the two European stress tests of March and December 2010 taking advantage of a widening of yield spreads in the sovereign bond market. Over time, there is an increase in “home bias” – greater exposure of domestic banks to its sovereign’s bonds – which is partly explained by the European Central Bank funding of these positions. On balance, our results are supportive of moral hazard in the form of risk-taking by under-capitalized banks to exploit low risk weights and central-bank funding of risky government bond positions.
    Keywords: banking crisis; home bias; regulatory arbitrage; risk-shifting; sovereign debt crisis
    JEL: F3 G01 G14 G15 G21 G28
    Date: 2013–04
  4. By: Jacob Gyntelberg; Peter Hördahl; Kristyna Ters; Jörg Urban
    Abstract: The recent sovereign debt crisis in the euro area has seen credit spreads on sovereign bonds and credit default swaps (CDS) surge for a number of member states. While these events have increased interest in understanding the dynamics of sovereign spreads in bond and CDS markets, there is little agreement in the literature as to whether one of the two markets is more important than the other in terms of price discovery of sovereign credit risk.
    Keywords: Sovereign credit risk, credit default swaps, price discovery, intraday
    Date: 2013–09
  5. By: Yan Sun; Pritha Mitra; Alejandro Simone
    Abstract: This paper studies the factors behind pro-cyclical but widely varying construction shares (as a percent of GDP) across countries, with a strong focus on European countries. Using a dataset covering 48 countries (including advanced and emerging economies within and outside Europe) for 1990-2011, we find that country’s geography, demographics, and economic conditions are the key determinants of a norm around which actual construction shares revolve in a simple AR(1) and error-correction process. The empirical results show that in many European countries, construction shares overshoot relative to their norms before the recent global crisis, but they have fallen significantly since the crisis. Nevertheless, there is still room for further adjustment in construction shares in some countries which may weigh on economic recovery.
    Keywords: Infrastructure;Europe;Euro Area;Housing;Tourism;Economic conditions;Demand;Business cycles;Developed countries;Developing countries;Cross country analysis;Construction, Business Cycle, Error-correction, European Growth
    Date: 2013–08–21
  6. By: Heather D. Gibson; Stephen G. Hall; George S. Tavlas
    Abstract: We investigate the impact of the economic fundamentals, sovereign credit ratings, political uncertainty, and the ECB’s Securities Markets Program (SMP) on Greek sovereign spreads. Our findings show that sovereign downgrades and political uncertainty appear to have been drivers of the sharp rises in Greek sovereign spreads from 2008-9 onwards, over-and-above the impact of the economic fundamentals. Our findings also show that prior to 2008-2009, the markets failed to incorporate Greece’s deteriorating fundamentals into the price of Greek sovereigns. We demonstrate that, once markets reassessed their pricing of Greek credit risk, the change in the influence of the fundamentals came swiftly and abruptly, exhibiting overshooting characteristics. The SMP reduced spreads while it was in operation.
    Keywords: euro area financial crisis, sovereign spreads
    JEL: E63 G12
    Date: 2013–09
  7. By: Martikainen, Emmi; Schmiedel, Heiko; Takalo, Tuomas
    Abstract: Financial integration in some segments of the financial markets started to deteriorate during the recent period of economic turmoil in Europe. This paper examines whether this phenomenon also holds true for the European retail payments market. In comparison with other segments of the financial markets, the integration of the retail payments market has been more difficult to quantify, and the effects of recent developments – including the creation of the Single Euro Payments Area (SEPA) and the economic crisis – have been hard to evaluate using existing measures of integration. As an indicator of financial integration, convergence in the European retail payments market is measured during the period 1995-2011 for the most used retail payment instruments: cash, debit card, credit card, direct debit, credit transfer, cheque and e-money. Two methods for estimating convergence are used: sigma convergence and beta convergence. There is some evidence of convergence for all payment instruments, except for cheques and e-money. The results suggest that the cross-country dispersion of the use of payment instruments has declined over time in Europe. The pace of convergence has picked up since the introduction of the single currency. There is also some evidence of beta convergence. In contrast to some other segments of the financial markets, integration in the retail payments market has not deteriorated during the financial crisis. JEL Classification: E12, E22, E47
    Keywords: convergence, financial integration, retail payments
    Date: 2013–06
  8. By: Beber, Alessandro; Brandt, Michael; Luisi, Maurizio
    Abstract: We construct daily real-time macroeconomic indices conditional on the rating of Eurozone countries. We uncover substantial explanatory power of our measures of economic fundamentals for yield dynamics beyond the traditional yield principal components. In particular, we find that the divergence in economic growth between AAA and non-AAA countries significantly explains the dynamics of sovereign yield spreads between the same groups of countries. The explanatory power of fundamentals is not subsumed by proxies of time-varying risk-aversion or by the perceived riskiness of the Eurozone banking sector. Finally, we cast this analysis of the Eurozone sovereign yields in an innovative term structure model, featuring our real-time macroeconomic factors conditional on country ratings.
    Keywords: real-time economic growth; sovereign yield spread
    JEL: G12
    Date: 2013–07
  9. By: Buch, Claudia M.; Körner, Tobias; Weigert, Benjamin
    Abstract: The agreement to establish a Single Supervisory Mechanism in Europe is a major step towards a Banking Union, consisting of centralized powers for the supervision of banks, the restructuring and resolution of distressed banks, and a common deposit insurance system. In this paper, we argue that the Banking Union is a necessary complement to the common currency and the Internal Market for capital. However, due care needs to be taken that steps towards a Banking Union are taken in the right sequence and that liability and control remain at the same level throughout. The following elements are important. First, establishing a Single Supervisory Mechanism under the roof of the ECB and within the framework of the current EU treaties does not ensure a sufficient degree of independence of supervision and monetary policy. Second, a European institution for the restructuring and resolution of banks should be established and equipped with sufficient powers. Third, a fiscal backstop for bank restructuring is needed. The ESM can play a role but additional fiscal burden sharing agreements are needed. Direct recapitalization of banks through the ESM should not be possible until legacy assets on banks' balance sheets have been cleaned up. Fourth, introducing European-wide deposit insurance in the current situation would entail the mutualisation of legacy assets, thus contributing to moral hazard. --
    Keywords: Banking Union,Europe,Single Supervisory Mechanism,Risk Sharing
    JEL: E02 E42 G18
    Date: 2013
  10. By: Anosova, Daria; Sonin, Konstantin; Vanags, Alf; Zasova, Anna
    Abstract: In terms of output decline and increase in unemployment, the economic recession in Latvia that started during the 2008-09 financial crisis was one of the most severe in the world. Using both decomposition of the unemployment rate into structural and cyclical components and Mortensen and Pissarides’ search and matching approach, we demonstrate that the changes in unemployment should be attributed primarily to cyclical, rather than structural factors; as of 2013, a large share of Latvian unemployment is still cyclical. Our results provide important implications for anti-crisis policy in Latvia and elsewhere in the world: the surge in unemployment was largely a consequence of Latvia’s austerity policy.
    Keywords: Beveridge curve; cyclical unemployment; labour market matching; structural unemployment
    JEL: E24 J60
    Date: 2013–06
  11. By: Erixon, Lennart (Dept. of Economics, Stockholm University)
    Abstract: In the mid-1990s, a Social Democratic government pursued an ambitious fiscal austerity policy in Sweden in the aftermath of a deep recession and public budget crisis. Economic advisors were guided by the idea that fiscal austerity would have neutral or expansionary effects on output and employment. In order to avoid large public deficits in the future the government also introduced radical fiscal rules. The main conclusion in this article is that the fiscal austerity measures in the mid-1990s delayed the Swedish economic recovery and that neither these measures nor the fiscal rules were responsible for the impressive Swedish macroeconomic performance in the following period. The positive economic development in Sweden was driven by export, profit and technology, reflecting an international upswing and the country’s flexible exchange rates and industrial composition. Similar beneficial conditions for expansion are not present in the EMU countries suffering from a budget and debt crisis today.
    Keywords: Fiscal austerity; Swedish stabilization policy; Swedish growth; fiscal rules
    JEL: C32 E22 E43 E62
    Date: 2013–09–04
  12. By: Reis, Ricardo
    Abstract: Between 2000 and 2012, the Portuguese economy grew less than the United States during the Great Depression and less than Japan during its lost decade. This paper asks why this happened, with a particular focus on the slump between 2000 and 2007. It describes the main facts of Portugal's recent economic history, evaluates some possible explanations for its dismal performance, and proposes a new hypothesis based on the misallocation of abundant capital flows from abroad. I put forward a model of credit frictions to show that if financial integration exceeds financial deepening, productivity will fall, generating a slump as relatively unproductive firms in the nontradables sector expand at the expense of more productive tradables firms. This explanation can also potentially account for the similarities and the differences between Portugal on the one hand, and Ireland and Spain on the other, during this period, and for some features of the crash in Portugal after 2010.
    Keywords: Eurozone; Financial imperfections; Sudden stop
    JEL: E32 E65 F32 F43 N14 O52
    Date: 2013–08
  13. By: Natascha Van Mechelen; Sarah Marchal
    Abstract: This paper aims to contribute to the debate on whether or not European welfare states converge by assessing trends and patterns of convergence and divergence of European minimum income schemes in the period 1992/2001-2012. We expand on previous studies on convergence of social assistance schemes in at least three ways. First, this paper provides a recent and detailed overview of social assistance benefit trends – detailed, that is, country-by-country. The focus is on cross-country variations rather than on the variation among groups of countries that are deemed to represent different welfare regimes. In addition, our analyses are based on original data drawn from a large network of country experts comprising all EU Member States except for Croatia, Cyprus and Malta. The country-focus as well as the involvement of national informants allows to contextualize our findings with regard to convergence and to clarify the underlying policy measures. Finally this paper covers a long time series, starting in the early 1990s up to 2012. We find that despite a marked increase in the spread of minimum income schemes, cross-country variation in the level of minimum income benefits has remained markedly stable. This stability however hides starkly different country experiences, with some laggard countries showing marked increases, whereas others continue to fall short. Some of these pre-crisis gains have evaporated in recent years. In addition, a substantial number of countries have allowed a further erosion of their benefit levels, especially in the 1990s, but still evident in the 2000s.
    Keywords: Minimum income schemes, EU, social policy, convergence, race to the bottom
    JEL: D31 I38 O52
    Date: 2013–08

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