nep-eec New Economics Papers
on European Economics
Issue of 2013‒11‒14
eleven papers chosen by
Giuseppe Marotta
University of Modena and Reggio Emilia

  1. The euro area's tightrope walk: debt and competitiveness in Italy and Spain By Zsolt Darvas
  2. Credit Rating Agency Announcements and the Eurozone Sovereign Debt Crises By Christopher F. Baum; Margarita Karpava; Dorothea Schäfer; Andreas Stephan
  3. TARGET2 imbalances and the need for a lender of last resort By Astarita, Caterina; Purificato, Francesco
  4. Would it have paid to be in the eurozone? By Michal Brzoza-Brzezina; Krzysztof Makarski; Grzegorz Wesolowski
  5. Fiscal consolidations and spillovers in the Euro area periphery and core By Jan in 't Veld
  6. Inflation and Output Comovement in the Euro Area: Love at Second Sight? By Michal Andrle; Jan Bruha; Serhat Solmaz
  7. A Comparison of GDP growth of European countries during 2008-2012 period from regional and other perspectives By Mazurek, Jiri
  8. May austerity be counterproductive? By Pablo García Sánchez; Miguel Sebastián
  9. Effects of fiscal consolidation envisaged in the 2013 Stability and Convergence Programmes on public debt dynamics in EU Member States By Katia Berti; Francisco de Castro; Matteo Salto
  10. How stressed are banks in the interbank market? By Abbassi, Puriya; Fecht, Falko; Weber, Patrick
  11. Linkages across sovereign debt markets By Cristina Arellano; Yan Bai

  1. By: Zsolt Darvas (Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences and Bruegel, Brussels, Belgium and Corvinus University Budapest)
    Abstract: Competitiveness adjustment in struggling southern euro-area members requires persistently lower inflation than in major trading partners, but low inflation worsens public debt sustainability. When average euro-area inflation undershoots the two percent target, the conflict between intra-euro relative price adjustment and debt sustainability is more severe. In our baseline scenario, the projected public debt ratio reduction in Italy and Spain is too slow and does not meet the European fiscal rule. Debt projections are very sensitive to underlying assumptions and even small negative deviations from GDP growth, inflation and budget surplus assumptions can easily result in a runaway debt trajectory. The case for a greater than five percent of GDP primary budget surplus is very weak. Beyond vitally important structural reforms, the top priority is to ensure that euro-area inflation does not undershoot the two percent target, which requires national policy actions and more accommodative monetary policy. The latter would weaken the euro exchange rate, thereby facilitating further intra-euro adjustment. More effective policies are needed to foster growth. But if all else fails, the European Central Bank's Outright Monetary Transactions could reduce borrowing costs.
    Keywords: competitiveness adjustment; debt sustainability; euro area; inflation
    JEL: E31 H68
    Date: 2013–10
  2. By: Christopher F. Baum (Boston College; DIW Berlin); Margarita Karpava (MediaCom London); Dorothea Schäfer (DIW Berlin; Jönköping International Business School); Andreas Stephan (Jönköping International Business School; DIW Berlin)
    Abstract: This paper studies the impact of credit rating agency (CRA) announcements on the value of the Euro and the yields of French, Italian, German and Spanish long-term sovereign bonds during the culmination of the Eurozone debt crisis in 2011-2012. The employed GARCH models show that CRA downgrade announcements negatively affected the value of the Euro currency and also increased its volatility. Downgrading increased the yields of French, Italian and Spanish bonds but lowered the German bond's yields, although Germany's rating status was never touched by CRA. There is no evidence for Granger causality from bond yields to rating announcements. We infer from these findings that CRA announcements significantly influenced crisis-time capital allocation in the Eurozone. Their downgradings caused investors to rebalance their portfolios across member countries, out of ailing states' debt into more stable borrowers' securities.
    Keywords: Credit Rating Agencies, Euro Crisis, Sovereign Debt, Euro Exchange Rate
    JEL: G24 G01 G12 G14 E42 E43 E44 F31 F42
    Date: 2013–11–01
  3. By: Astarita, Caterina; Purificato, Francesco
    Abstract: This paper analyses the issue of the dynamics of the TARGET2 system balances during the sovereign debt crisis. The development of these balances reflects the change in the distribution of the monetary base among the EMU Member States. During the sovereign debt crisis, while some countries, among which Germany, registered a decisive inflow of monetary base, some others, as Italy, shown an outflow. The main conclusion of the paper is that the dynamics in TARGET2 is rather due to a fall in the level of confidence in the capacity of the EMU to survive than to disparities in the level of competitiveness among countries of the Eurozone as a part of the literature maintained. In turn, this crisis of confidence has to be considered as the consequence of the implicit refusal of the European institutions of creating a mechanism working as “lender of last resort” for the Eurozone Member States. Two elements, in particular, support this thesis. On the one hand, most of the monetary base outflow occurred in coincidence with those political decisions which determined deterioration in the expectation about the degree of solvency of the periphery countries. On the other hand, the fiscal consolidation that the periphery countries implemented destabilized the economy as a result of a negative conjuncture and a monetary policy ineffective in reducing the interest rate.
    Keywords: payment system, monetary policy, fiscal policy, financial crisis
    JEL: E42 E52 E58 E62 F32 F34 F36
    Date: 2013–10
  4. By: Michal Brzoza-Brzezina (National Bank of Poland, Warsaw School of Economics); Krzysztof Makarski (National Bank of Poland, Warsaw School of Economics); Grzegorz Wesolowski (National Bank of Poland, Warsaw School of Economics)
    Abstract: Giving up an independent monetary policy and a flexible exchange rate are the key sources of costs and benefits entailed to joining a monetary union. In this paper we analyze their ex post impact on the stability of the Polish economy during the recent financial crisis. To this end we construct a small open economy DSGE model and estimate it for Poland and the euro area. Then we run a counterfactual simulation, assuming Poland's euro area accession in 1q2007. The results are striking - volatilities of GDP and inflation increase substantially. In particular, had Poland adopted the euro, GDP growth would have oscillated between -6% and +9% (-9% to +11% under more extreme assumptions) instead of between 1% and 7%. We conclude that during the analyzed period independent monetary policy and, in particular, the flexible exchange rate played an important stabilizing role for the Polish economy.
    Keywords: optimum currency area, euro-area accession, emerging market
    JEL: E32 E58 E65
    Date: 2013–10–23
  5. By: Jan in 't Veld
    Abstract: A model-based assessment of the macro-economic impact of consolidations and their spillovers in the euro area in 2011-13. This paper uses a structural multi-country model to assess the impact of fiscal consolidation measures undertaken in 2011-13 in the EA periphery and core. The simulations assume 'crisis' conditions prevailing (high share of constrained households, ZLB). The GDP effects depend crucially on the composition of the consolidation and on how quickly expectations are affected. Expenditure-based consolidations have larger impact multipliers than revenue-based consolidations. Average multipliers for domestic fiscal shocks range from 0.5 and 1, depending on the degree of openness. But spillovers of fiscal consolidations are large, with both the demand channel and the competitiveness channel adding to the negative GDP effects. Higher risk premia add further to the negative GDP effects. Spillovers from consolidations in Germany and core EA have worsened the overall economic situation. A temporary fiscal stimulus in surplus countries can boost output and help reduce their current account surpluses. The improvement in current account deficits in the periphery is however small.
    Date: 2013–10
  6. By: Michal Andrle; Jan Bruha; Serhat Solmaz
    Abstract: This paper discusses comovement between inflation and output in the euro area. The strength of the comovement may not be apparent at first sight, but is clear at business cycle frequencies. We propose a new estimation approach to trimmed mean inflation, determining jointly the upper and lower quantiles to be trimmed, as well as the frequency bandwidth of real output that best aligns inflation with the output cycle. Our results suggest that at business cycle frequency, the comovement of output and core inflation is high and stable, and that inflation lags behind the output cycle with roughly half of its variance. The strong relationship between output and inflation hints at the importance of demand shocks for the euro area business cycle.
    Keywords: Business cycle, core inflation, demand shocks, trimmed mean.
    JEL: C10 E32 E50
    Date: 2013–08
  7. By: Mazurek, Jiri
    Abstract: The aim of the article is to compare total real GDP growth of European countries from the 3rd quarter of 2008 to the 3rd quarter of 2012, that is the period from the start of the Great recession in European Union to the present day. This period is characterized by a predominant economic stagnation or an economic recession, which occurred in the majority of examined European countries. Countries were divided into groups based on the following grounds: whether they are geographically close the economic center (Germany) or periphery, whether they are in Eurozone or not, whether they are (new) EU members or not, etc. The main findings from the comparisons are as follows: 1. European countries close to the economic center (Germany and its neighbours) experienced positive economic growth during examined period on average, while countries from European periphery experienced negative economic growth on average during the same period. This difference was found statistically significant at α = 0.01 level. 2. Differences between Eurozone and non-Eurozone and differences between old and new EU members were found statistically insignificant. 3. Among European regions with the most negative real total GDP growth were countries from Baltics, Balkans, Southern Europe (Italy, Portugal) and Iceland. The most successfull countries with the most positive real total GDP growth were countries of central Europe (Poland, Slovakia, Germany, Switzerland, Austria) and Northern Europe (Sweden and Norway).
    Keywords: economic growth, European union, international economics, European regions.
    JEL: F43 F44 O47 O57 R11
    Date: 2013–11–03
  8. By: Pablo García Sánchez; Miguel Sebastián (Universidad Complutense de Madrid)
    Abstract: This paper investigates the impact that fiscal policy has on economic activity and sovereign debt during economic downturns in the euro area, mainly Germany and Spain. Our theoretical and empirical framework shows that the macroeconomic returns of austerity crucially depend on the values of fiscal multipliers. We find that, for the Spanish economy, even if policy makers just focus on the public debt ratio, ignoring output and unemployment, policies of deficit reduction may be self-defeating, especially if carried on via tax increases. In fact, counter cyclical policies beat deficit consolidation policies in stabilizing the sovereign debt ratio, no matter if shocks are on aggregate supply or aggregate demand. By contrast, in the German case, we cannot reject the hypothesis that austerity works, even under a sluggish economy.
    Keywords: Sovereign Debt, Fiscal Policy, Fiscal Multipliers
    JEL: E62 H30 H63
    Date: 2013–10
  9. By: Katia Berti; Francisco de Castro; Matteo Salto
    Abstract: This paper presents a simple analysis of the public debt-to-GDP ratio responses to fiscal consolidation efforts envisaged in the 2013 Stability and Convergence Programmes presented by EU Member States. In this paper we assess the response of the debt-to-GDP ratio to the fiscal consolidation efforts envisaged in the 2013 Stability and Convergence Programmes (SCPs) presented by EU Member States, under different assumptions on the underlying fiscal multipliers. The effects of fiscal consolidation are assessed against a counterfactual no-consolidation scenario, in which the structural primary balance is kept constant at 2012 value. We show that large fiscal multipliers lead to temporary increases in the debt ratio following consolidation, relative to the no-consolidation baseline. However, for high but plausible values of the multipliers, such counter-intuitive effects are relatively short-lived (maximum three years from the beginning of the consolidation programme). Increases in the debt ratio are anyway more protracted if financial markets react myopically to consolidation efforts (demanding higher yields). Despite the possible negative short-term effects, consolidation is needed as the debt dynamic in absence of policy intervention is in many cases quite steep and further debt increases would raise the likelihood of a self-defeating dynamics in the future. Based on our simple analytical framework, short-term increases in the debt ratio (relative to baseline) following consolidation could take place for a group of countries expected to experience high fiscal multipliers, including Belgium, Cyprus, France, Greece, Italy, Ireland, Portugal, Slovenia and Spain.
    JEL: E62 H63
    Date: 2013–09
  10. By: Abbassi, Puriya; Fecht, Falko; Weber, Patrick
    Abstract: We use a unique data set that comprises each bank's bids in the Eurosystem's main refinancing operations and its recourse to the LOLR facility (a) to derive banks' willingness-to-pay for liquidity through a one-week repo and (b) to show that a bank's willingness-to-pay is a good indicator for the probability that this bank draws on the LOLR facility. Our results suggest (i) that banks' willingness-to-pay for liquidity indeed reflects refinancing conditions in the interbank market and (ii) that the willingness-to-pay can serve as an early warning indicator for banking distress. --
    Keywords: banks,liquidity,LOLR facility,repos,money markets,frictions
    JEL: D44 E42 E58 G21
    Date: 2013
  11. By: Cristina Arellano; Yan Bai
    Abstract: We develop a multicountry model in which default in one country triggers default in other countries. Countries are linked to one another by borrowing from and renegotiating with common lenders with concave payoffs. A foreign default increases incentives to default at home because it makes new borrowing more expensive and defaulting less costly. Foreign defaults tighten home bond prices because they lower lenders' payoffs. Foreign defaults make home default less costly by lowering future recoveries, because countries can extract more surplus if they renegotiate simultaneously. In our model, the home country may default only because the foreign country is defaulting. This dependency arises during fundamental foreign defaults, where the foreign country defaults because of high debt and low income, and also during self-fulfilling defaults, where both countries default only because the other is defaulting. The simultaneity in defaults induces a correlation in interest rate spreads across countries. The model can rationalize some of the recent economic events in Europe.
    Keywords: Europe ; Debt
    Date: 2013

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