nep-eec New Economics Papers
on European Economics
Issue of 2013‒12‒29
nineteen papers chosen by
Giuseppe Marotta
University of Modena and Reggio Emilia

  1. “European Government Bond Markets and Monetary Policy Surprises: Returns, Volatility and Integration” By Pilar Abad; Helena Chuliá
  2. On the time-varying relationship between EMU sovereign spreads and their determinants By Afonso, António; Arghyrou, Michael G.; Bagdatoglou, George; Kontonikas, Alexandros
  3. Fiscal devaluation in a Monetary Union By Engler, Philipp; Ganelli, Giovanni; Tervala, Juha; Voigts, Simon
  4. Why firms avoid cutting wages: Survey evidence from European firms By Philip Du Caju; Theodora Kosma; Martina Lawless; Julian Messina; Tairi Rõõm
  5. Euro area structural convergence? A multi-criterion cluster analysis. By Irac, D.; Lopez, J.
  6. The Forward Premium Puzzle and The Euro By Jun, Nagayasu
  7. Transitions in Labour Market Status in the EU By Ward-Warmedinger, Melanie E.; Macchiarelli, Corrado
  8. Political Legitimacy in a Non-optimal Currency Area By Vera van Hüllen
  9. Ending uncertainty: recapitalisation under European Central Bank supervision By Silvia Merler; Guntram B. Wolff
  10. Is Europe growing together or growing apart? By Crowley, Patrick; Garcia, Enrique; Quah , Chee-Heong
  11. Assessing the losses in euro area potential productivity due to the financial crisis. By Chouard, V.; Fuentes Castro, D.; Irac, D.; Lemoine, M.
  12. Determinants of relative bargaining power in monetary unions By Brigitte Granville; Dominik Nagly
  13. Macroeconomic Dynamics in Four Selected New Member States of the EU By Pasquale Foresti; Ugo Marani; Giuseppe Piroli
  14. Sovereign risk contagion in the Eurozone: a time-varying coefficient approach By Ludwig, Alexander
  15. Post Crisis “Success” Stories? Economic Outcomes And Social Progress In Iceland And Latvia By Hilmar Þór Hilmarsson
  16. Monetary and Macroprudential Policy in an Estimated DSGE Model of the Euro Area By Pau Rabanal; Dominic Quint
  17. The dynamics of bank loans short-term interest rates in the Euro area: what lessons can we draw from the current crisis? By Avouyi-Dovi, S. Patrick Sevestre.; Horny, G.; Sevestre, P.
  18. The State of the Banking Sector in Europe By Dirk Schoenmaker; Toon Peek
  19. Which size and evolution of the government expenditure multiplier in France (1980-2010)? By Cléaud, G.; Lemoine, M.; Pionnier, P.-A.

  1. By: Pilar Abad (University Rey Juan Carlos and University of Barcelona); Helena Chuliá (Faculty of Economics, University of Barcelona)
    Abstract: In this paper we investigate the response of bond markets to euro area and US monetary policy shocks. Specifically, we analyze the effect of unexpected changes in interest rates implemented by the European Central Bank (ECB) and the Federal Open Market Committee (FOMC) not only on the returns, but also on the volatility and the integration of European government bond markets. For all three characteristics our results show that the response to monetary policy surprises varies across groups of countries (EMU EU-15 central, EMU EU-15 peripheral, non-EMU EU-15 and non-EMU new EU). We also find that the effects of monetary policy announcements on the level of integration are more pronounced than those on returns and volatility. Finally, our results paint a complex picture of the effects of monetary policy news releases on the level of integration. The effect of ECB monetary policy surprises differs across old and new European Union members, while the effect of FOMC monetary policy surprises differs across EMU and non-EMU members.
    Keywords: Monetary policy announcements; Bond market integration; Interest rate surprises. JEL classification: E44; F36; G15.
    Date: 2013–12
  2. By: Afonso, António; Arghyrou, Michael G.; Bagdatoglou, George; Kontonikas, Alexandros
    Abstract: We use a dynamic multipath general-to-specific algorithm to capture structural instability in the link between euro area sovereign bond yield spreads against Germany and their underlying determinants over the period January 1999 – August 2011. We offer new evidence suggesting a significant heterogeneity across countries, both in terms of the risk factors determining spreads over time as well as in terms of the magnitude of their impact on spreads. Our findings suggest that the relationship between euro area sovereign risk and the underlying fundamentals is strongly timevarying, turning from inactive to active since the onset of the global financial crisis and further intensifying during the sovereign debt crisis. As a general rule, the set of financial and macro spreads’ determinants in the euro area is rather unstable but generally becomes richer and stronger in significance as the crisis evolves.
    Keywords: euro area, crisis, spreads, time-series analysis, time-varying relationship,
    Date: 2013
  3. By: Engler, Philipp; Ganelli, Giovanni; Tervala, Juha; Voigts, Simon
    Abstract: Between 1999 and the onset of the economic crisis in 2008 real exchange rates in Greece, Ireland, Italy, Portugal and Spain appreciated relative to the rest of the euro area. This divergence in competitiveness was reflected in the emergence of current account imbalances. Given that exchange rate devaluations are no longer available in a monetary union, one potential way to address such imbalances is through a fiscal devaluation. We use a DSGE model calibrated to the euro area to investigate the impact of a fiscal devaluation, modeled as a revenue-neutral shift from employers´ social contributions to the Value Added Tax. We find that a fiscal devaluation carried out in Southern European countries has a strong positive effect on output, but a mild effect on the trade balance of these countries. In addition, the negative effect on Central-Northern countries output is weak. --
    Keywords: fiscal devaluation,fiscal policy,euro area,currency union,current account
    JEL: E32 E62 F32 F41
    Date: 2013
  4. By: Philip Du Caju (National Bank of Belgium, Research Department); Theodora Kosma (Bank of Greece); Martina Lawless (Central Bank of Ireland); Julian Messina (World Bank; Universitat de Girona); Tairi Rõõm (Eesti Pank, Estonia)
    Abstract: The rarity with which firms reduce nominal wages has been frequently observed, even in the face of considerable negative economic shocks. This paper uses a unique survey of fourteen European countries to ask firms directly about the incidence of wage cuts and to assess the relevance of a range of potential reasons for why they avoid cutting wages. Concerns about the retention of productive staff and a lowering of morale and effort were reported as key reasons for downward wage rigidity across all countries and firm types. Restrictions created by collective bargaining were found to be an important consideration for firms in euro area countries but were one of the lowest ranked obstacles in non-euro area countries. The paper examines how firm characteristics and collective bargaining institutions affect the relevance of each of the common explanations put forward for the infrequency of wage cuts.
    Keywords: labour costs, wage rigidity, firm survey, wage cuts, European Union
    JEL: J30 J32 J33 J51 C81 P5
    Date: 2013–12
  5. By: Irac, D.; Lopez, J.
    Abstract: This paper proposes a classification of the old member countries of the euro area in a structural data rich environment and run a convergence analysis using the same framework. First, we use a clustering approach and identify two structurally distinct groups of countries that are not modified between 1995 and 2007: the South Countries Group (SCG) – composed of Greece, Italy, Portugal and Spain – and the Other Countries Group (OCG). Second, we propose a convergence metrics and reach three key findings: (i) increase over time of the between-group dispersion; (ii) diverging demographics and innovation performance into the OCG, and (iii) an unfortunate convergence towards high labour market duality in the SCG.
    Keywords: Cluster Analysis, European Monetary Union, Structural Policies.
    JEL: C38 E02 F33
    Date: 2013
  6. By: Jun, Nagayasu
    Abstract: This paper evaluates the forward premium puzzle using the Euro exchange rate. Unlike previous studies, our analysis utilizes time-varying parameter methods and is based on two approaches for evaluation of the puzzle; the traditional approach analyzing the sensitivity of interest rate differentials to the forward premium, and the other looking into deviations from the covered interest rate parity (CIRP) condition. Then we provide evidence that the forward premium puzzle indeed became more prominent around the time of the recent crisis periods such as the Lehman Shock and the Euro crisis. This is also shown to be consistent with a deterioration in the CIRP.
    Keywords: forward premium puzzle, risk premium, time-varying parameters, financial crises,
    Date: 2013
  7. By: Ward-Warmedinger, Melanie E. (European Central Bank); Macchiarelli, Corrado (London School of Economics)
    Abstract: This paper presents information on labour market mobility in 23 EU countries, using Eurostat's Labour Force Survey (LFS) data over the period 1998-2008. More specifically, it discusses alternative measures of labour market churning; including the ease with which individuals can move between employment, unemployment and inactivity over time. The results suggest that the probability of remaining in the same labour market status between two consecutive periods is high for all countries. Nonetheless, transitions from unemployment and inactivity back into the labour market are relatively weak in the euro area and central eastern European EU (CEE EU) countries compared to Denmark and, particularly, Sweden. Moreover, comparisons of transition probabilities over time suggest that – until the onset of the financial crisis – the probability of remaining in unemployment over two consecutive periods decreased in Sweden, the euro area, and, to a lesser extent, Denmark, while it increased in the average CEE EU countries. At the same time, however, successful labour market entries (from outside the labour market) increased in the average CEE EU countries, Denmark and Sweden. On the basis of an index for labour markets turnover used in the paper (Shorrocks, 1987), labour markets in Spain, Luxemburg, the Netherlands, Denmark and Sweden are the most mobile on average, with these results mainly reflecting higher mobility of people below the age of 29, highly educated and female workers. We also find that mobility of all worker groups has generally increased over time in the euro area, Denmark and Sweden. Finally, we ask whether some of the observed changes in mobility can be broadly restraint to some "macro" explanatory factors, including part time and temporary employment, unemployment and structure indicators. The results provide a mixed picture, suggesting that the sense of mobility strongly varies across countries.
    Keywords: transition probabilities, labour market mobility, LFS micro data, EU countries
    JEL: J21 J60 J82 E24
    Date: 2013–12
  8. By: Vera van Hüllen
    Abstract: On the basis of a brief reconstruction of the causes and impacts of the Euro crisis, this paper explores, counterfactually and hypothetically, whether the new Euro regime, insisting on fiscal austerity and supply-side reforms, could have prevented the rise of the crisis or is able to deal with its disastrous economic and socialimpact. A comparison with the likely impact of transfer-based Keynesian reflation suggests that, in both cases, economic success is uncertain, while both approaches are likely to produce severely negative sideeffects. In light of such dismal policy choices, attempts to politicize European election campaigns are morelikely to provoke unmanageable policy conflict than to overcome the input-oriented, democratic deficit ofEuropean economic governance
    Keywords: fiscal policy; Euro; European elections; legitimacy
    Date: 2013–10–17
  9. By: Silvia Merler; Guntram B. Wolff
    Abstract: Estimates of the recapitalisation needs of the euro-area banking system vary between â?¬50 and â?¬600 billion. The range shows the considerable uncertainty about the quality of banksâ?? balance sheets and about the parameters of the forthcoming European Central Bank stress tests, including the treatment of sovereign debt and systemic risk. Uncertainty also prevails about the rules and discretion that will applyto bank recapitalisation, bank restructuring and bank resolution in 2014 and beyond. The ECB should communicate the relevant parameters of its exercise early and in detail to give time to the private sector to find solutions. The ECB should establish itself as a tough supervisor and force non-viable banks into restructuring. This could lead to short-term financial volatility, but it should be weighed against the cost of a durably weak banking system and the credibility risk to the ECB. The ECB may need to provide large amounts of liquidity to the financial system. Governments should support the ECB, accept cross-border bank mergers and substantial creditor involvement under clear bail-in rules and should be prepared to recapitalise banks. Governments should agree on the eventual creation of a single resolution mechanism with efficient and fast decision-making procedures, and which can exercise discretion where necessary. A resolution fund, even when fully built-up, needs to have a common fiscal backstop to be credible.
    Date: 2013–12
  10. By: Crowley, Patrick (College of Business, Texas A&M University, Corpus Christi); Garcia, Enrique (Universita Autonoma de Mexico); Quah , Chee-Heong (University of Malaysia)
    Abstract: While it is painfully clear that the ’ever closer’ monetary and financial union in the EU has run into serious trouble there has been very little study of the degree to which the countries have become similar or different in their economic growth dynamics. This paper therefore goes beyond the traditional convergence literature to look at their dynamic convergence and explore the path of their changing similarity in the frequency domain. The results show that while a core group of countries may be developing together, there appears to be at least seven identifiable groups of countries with different growth dynamics. Greece appears to be in a class on its own. Business cycles are important but longer-term trends and higher frequency fluctuations all have a role to play in facilitating adjustment. These results provide awkward implications for policy, particularly for those who thought that simply having a union would draw countries closer together (endogenous OCA criteria).
    Keywords: business cycles; growth cycles; frequency domain; wavelet analysis; cluster analysis; euro area; European Union; optimal currency area
    JEL: C49 E32
    Date: 2013–12–18
  11. By: Chouard, V.; Fuentes Castro, D.; Irac, D.; Lemoine, M.
    Abstract: In this paper, we show that the recent financial crisis has significantly affected the potential total factor productivity (TFP) of the four largest euro area economies, as well as that of the rest of the euro area. We used a reduced-form equation of TFP, based on an approach recently developed by Cahn and Saint-Guilhem (2010). Our empirical findings show that the permanent impact on potential TFP varies across countries from -3.9 points to -1.3 points in Q2 2012. When these losses are incorporated, TFP gaps develop closely in line with capacity utilisation rates (CUR). Moreover, in the case of France, including CUR in our TFP model improves the quasi real-time reliability of TFP gap estimates.
    Keywords: production function, total factor productivity, financial crisis, capacity utilisation.
    JEL: E22 E23 E32 O4
    Date: 2013
  12. By: Brigitte Granville; Dominik Nagly
    Abstract: This paper studies the bargaining power of the debtors versus the creditors in Europe’s Economic and Monetary Union (EMU).
    Keywords: Bargaining power, competitiveness, disagreement cost, European Monetary Union, internal devaluation, transfer union
    JEL: C79 E02 E42 E58 E61
    Date: 2013–12
  13. By: Pasquale Foresti; Ugo Marani; Giuseppe Piroli
    Abstract: In this paper, we employ a block structured near-vector autoregression in order to compare the reactions to euro-area shocks in four New Member States (Bulgaria, Hungary, Czech Republic and Romania) and in the Old Member State of the EU. Thanks to the methodology adopted we also study the effects of national economic policies and their reactions to national shocks in each New Member State. Our analysis highlights that possible asymmetric effects of the ECB's monetary policy cannot be excluded and that the potential accession of the New Member States may increase the level of fiscal indiscipline in the eurozone.
    Keywords: Monetary Union, Monetary and Fiscal Policies Interaction, Economic Shocks.
    JEL: E52 E61 F33 F36
    Date: 2013–12–14
  14. By: Ludwig, Alexander
    Abstract: This paper analyzes sovereign risk contagion in the Eurozone using an extension to the canonical model for contagion proposed by Pesaran and Pick (2007) and Metiu (2012) to allow for time-varying coefficients. This becomes necessary due to changes in the risk pricing of sovereign bonds since the onset of the recent crisis period and due to the presence of contagion in typically bounded time intervals. Controlling for changes in the risk pricing by investors, we detect several channels of pure contagion between 2008 and 2012. Further, we find that the bailout-programs for Greece, Ireland and Portugal led to a disruption in contagion of sovereign risk from these countries to Spain, Italy, France and Belgium as was desired by policymakers. For all countries considered, we observe an increase in the relevance of general risk aversion towards sovereign debt since May 2010. This development partially replaced the significance of country-specific credit risk factors in explaining bond yield spreads. Our model extension yields a device that is suitable to determine whether policy interventions are required and to judge their success ex-post.
    Keywords: contagion; credit events; Eurozone; financial crisis; sovereign risk; time-varying approach
    JEL: C32 E44 F34 G01 G15
    Date: 2013–12–05
  15. By: Hilmar Þór Hilmarsson (University of Akureyri, Stockholm School of Economics in Riga)
    Abstract: The global crisis hit hard in Iceland and Latvia. Economic development prior to the crisis, as well as response to the crisis, was different in these two countries, also yielding different results. Prior to the crisis both countries privatized their banking system. In Iceland the banks were sold to local investors. The Latvian banks were primarily owned by international investors. During the crisis Iceland nationalized its largest banks. In Latvia the foreign owned banking system survived. In Iceland a large currency depreciation took place that boosted exports and mitigated the GDP decline. In Latvia the national currency is linked to the Euro and did not depreciate and Latvia suffered a large GDP decline with high unemployment. Thus both the privatization of the banking system prior to the crisis was very different as well as the response to the crisis. The post crisis economic situation in Latvia and Iceland is also different. Latvia’s reform program has been characterized by austerity while the adjustment in Iceland seems much milder, e.g. with lower unemployment. Iceland seems to have been successful in protecting its social fabric while the human costs of adjustment seem high in Latvia. The fact that these two countries responded so differently to the crisis makes a comparative case study feasible. While this study focuses on Iceland and Latvia it can also yield interesting results for other cases. Important lessons can be learned about the effects of different policy responses during times of crisis. This comparative case study is based on a review of theoretical literature, interviews, secondary data and the author’s previous experience as a staff member of the World Bank in Latvia and as Special Advisor to the Foreign Minister of Iceland.
    Date: 2013–12
  16. By: Pau Rabanal (IMF); Dominic Quint (Free University Berlin)
    Abstract: In this paper, we study the optimal mix of monetary and macroprudential policies in an estimated two-country model of the euro area. The model includes real, nominal and financial frictions, and hence both monetary and macroprudential policies can play a role. We find that the introduction of a macroprudential rule would help in reducing macroeconomic volatility, improve welfare, and partially substitute for the lack of national monetary policies. Macroprudential policies always increase the welfare of savers, but their effects on borrowers depend on the shock that hits the economy. In particular, macroprudential policies may entail welfare costs for borrowers under technology shocks, by increasing the countercyclical behavior of lending spreads.
    Date: 2013
  17. By: Avouyi-Dovi, S. Patrick Sevestre.; Horny, G.; Sevestre, P.
    Abstract: In this paper, I study how the CEO's election can be biased if some directors in the board belong to the same network. I use a static Bayesian game. Directors want to elect the best candidate but they also want to vote for the winner. In that context, results show that, when no candidate is part of the network, boards with a network perform better in electing the right candidate. On the other hand, it becomes detrimental for stockholders if one candidate is part of the network. Indeed, compared to a situation where there are no interconnections between directors, the directors who are members of a network vote more often for the candidate they think is best, rather than for the one they think might win. The ones who are not part of the network follow their lead. Thus the network has power on the result of the election and therefore limits the power of the future CEO.
    Keywords: bank interest rates; diffusion model; stochastic volatility; Bayesian econometrics.
    JEL: F14 J51
    Date: 2013
  18. By: Dirk Schoenmaker; Toon Peek
    Abstract: This paper reviews the state of the banking sector in Europe. At the aggregate level, the empirical data suggest that the Baltics, Cyprus, Greece and Ireland, in particular, are hit by a strong decline in lending in the wake of the financial crisis. This deleveraging is mainly caused by a reduction in cross-border supply of credit. We also examine the capital position of the European banking system, using November 2013 stock market data. In the basic scenario to restore capital to a market based leverage ratio of 3%, EUR 84 billion of extra capital would be needed for the largest 60 banks. At the bank level, the top tertile of well-capitalised banks (with a market based leverage ratio well above 4%) continues lending. By contrast, the 2nd tertile of medium-capitalised banks (between 3 and 4%) and the 3rd tertile of weakly capitalised banks (well below 3%) show a strong decline in lending. Moreover, the market-to-book ratio is below one for these banks. The market thus gives a lower value to these banks. Our findings provide prima facie evidence of a credit crunch in Europe. Another fallout of the financial crisis is an increase, though very modest, of concentration in banking in the distressed countries (Greece, Ireland, Portugal, Spain and Italy). The enhancement of financial stability through (forced) M&As seems to come at the expense of reduced competition. L'état du secteur bancaire en Europe Ce document examine l'état du secteur bancaire en Europe. Au niveau agrégé, les données empiriques suggèrent que les pays baltes, Chypre, la Grèce et l'Irlande, en particulier, sont touchés par une forte diminution du crédit à la suite de la crise financière. Ce désendettement est principalement dû à une réduction de l'offre transfrontalière de crédit. Nous examinons également la capitalisation du système bancaire européen, en utilisant les données boursières de novembre 2013. Dans le scénario de base qui consiste à restaurer à 3 % le ratio de levier fondé sur la capitalisation boursière, 84 milliards d’euros de capitaux supplémentaires seraient nécessaires pour les 60 plus grandes banques. Au niveau des banques, le tiers supérieur des banques les mieux capitalisées (avec un ratio de levier fondé sur la capitalisation boursière bien au-dessus de 4 %) continue de prêter. En revanche, le deuxième tiers de banques de capitalisation intermédiaire (entre 3 et 4 %) et le troisième tiers des banques faiblement capitalisées (bien en-dessous de 3 %) montrent une forte diminution des prêts. En outre, le ratio entre valeur de marché et valeur comptable est inférieur à un pour ces banques. Le marché donne ainsi à ces banques une valeur inférieure. Nos résultats fournissent la preuve prima facie d'une chute du crédit en Europe. Une autre retombée de la crise financière est une augmentation, bien que très modeste, de la concentration du secteur bancaire dans les pays en difficulté (Espagne, Grèce, Irlande, Italie et Portugal). Le renforcement de la stabilité financière à travers des fusions et acquisitions (forcées) semble se faire au détriment de la concurrence.
    Keywords: capital, credit supply, banks, geographical segmentation, deleveraging, cross-border banking, activité bancaire transfrontalière, segmentation géographique, banques, capital, offre de crédit, désendettement
    JEL: D40 F36 G21 G28
    Date: 2013–12–13
  19. By: Cléaud, G.; Lemoine, M.; Pionnier, P.-A.
    Abstract: The importance of the stimulus packages that were injected in most advanced economies from the start of the financial crisis and the speed at which budgets are now being consolidated in Europe has revived the long-lasting debate on the size of fiscal multipliers. In this study, we focus on government expenditures on goods and services. Our conclusion following Blanchard and Perotti (2002) for the identification of government spending shocks is that the multiplier is significant and not far from 1 on impact and becomes statistically insignificant after about 3 years in France. We provide numerous robustness checks concerning the definition of expenditures, assumptions about data stationarity, the role of expectations and the choice of the sample. Moreover, using a time-varying SVAR model, our main findings are (1) that the multiplier did not evolve significantly at any horizon since the beginning of the 1980s and (2) that the variance of shocks hitting the economy evolves a lot more than the model autoregressive parameters. Even in alternative specifications where the Bayesian priors are pushed towards time-variation, the main evolution that we uncover is a (non-significant) decrease of the medium term expenditure multiplier, partly linked to a more aggressive monetary policy since the 1990s. We do not find evidence of an increase of the multiplier during every recession in France, contrary to the finding of Auerbach and Gorodnichenko (2012) for the United States. At least, business cycle conditions do not seem to be the main driver of the evolution of the expenditure multiplier in the last 30 years in France.
    Keywords: Government expenditure multiplier, Evolution, TV-SVAR.
    JEL: E62 C54
    Date: 2013

This nep-eec issue is ©2013 by Giuseppe Marotta. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.