nep-eec New Economics Papers
on European Economics
Issue of 2014‒04‒05
twenty papers chosen by
Giuseppe Marotta
University of Modena and Reggio Emilia

  1. The euro plus pact: cost competitiveness and external capital flows in the EU countries By Gabrisch, Hubert; Staehr, Karsten
  2. External and macroeconomic adjustment in the larger euro area countries By Angelini, Elena; Ca' Zorzi, Michele; Forster, Katrin
  3. Financial conditions index and credit supply shocks for the euro area By Darracq Pariès, Matthieu; Maurin, Laurent; Moccero, Diego
  4. The pricing of sovereign risk and contagion during the European sovereign debt crisis By Beirne, John; Fratzscher, Marcel
  5. Cross-border production chains and business cycle co-movement between Central and Eastern European countries and euro area member states By Iossifov, Plamen
  6. Why firms avoid cutting wages: survey evidence from European firms By Philip Du Caju; Theodora Kosma; Martina Lawless; Julian Messina; Tairi Room
  7. Is It Too Late to Bail Out the Troubled Countries in the Eurozone? By Conesa, Juan Carlos; Kehoe, Timothy J.
  8. The impact of news and the SMP on realized (co)variances in the eurozone sovereign debt market By Beetsma, Roel; de Jong, Frank; Giuliodori, Massimo; Widijanto, Daniel
  9. European Integration: Partisan Motives or Economic Benefits? By Patricia Esteve-González & Bernd Theilen
  10. Reforming EU economic governance: is ‘more’ any better? By Renaud Thillaye; Ludek Kouba; Andreas Sachs
  11. A high frequency assessment of the ECB securities markets programme By Ghysels, Eric; Idier, Julien; Manganelli, Simone; Vergote, Olivier
  12. Anatomy of a Bail-In By Thomas Conlon; John Cotter
  13. Transmission effects in the presence of structural breaks: evidence from south-eastern European countries By Minoas Koukouritakis; Athanasios P. Papadopoulos; Andreas Yannopoulos
  14. Putting the EMU integration into a new perspective: the case of capital market holdings By George T. Palaiodimos
  15. Nonlinearities in sovereign risk pricing the role of cds index contracts By Anne Laure Delatte
  16. Financial flexibility across the euro area and the UK By Ferrando, Annalisa; Marchica, Maria-Teresa; Mura, Roberto
  17. Cross-country insurance mechanisms in currency unions By Nancy van Beers; Michiel Bijlsma; Gijsbert T. J. Zwart
  18. Macroeconomic experiences and risk taking of euro area households By Ampudia, Miguel; Ehrmann, Michael
  19. Sovereign credit ratings, market volatility, and financial gains By Afonso, António; Gomes, Pedro; Taamouti, Abderrahim
  20. Reallocation of Resources Across Age in a Comparative European Setting By Bernhard Hammer; Alexia Prskawetz; Inga Freund

  1. By: Gabrisch, Hubert; Staehr, Karsten
    Abstract: The Euro Plus Pact was approved by 23 EU countries in March 2011 and came into force shortly afterwards. The Pact stipulates a range of quantitative targets meant to strengthen cost competitiveness with the aim of preventing the accumulation of external financial imbalances. This paper uses Granger causality tests and vector autoregressive models to assess the short-term linkages between changes in the relative unit labour cost and changes in the current account balance. The sample consists of annual data for 27 EU countries for the period 1995-2012. The main finding is that changes in the current account balance precedes changes in relative unit labour costs, while there is no discernible effect in the opposite direction. The divergence in unit labour costs between the countries in Northern Europe and the countries in Southern and Eastern Europe may thus partly be the result of capital flows from the core of Europe to the periphery prior to the global financial crisis. The results also suggest that the measures in the Euro Plus Pact to restrain the growth of unit labour costs may not affect the current account balance in the short term. JEL Classification: E61, F36, F41
    Keywords: current account imbalances, economic crisis, European integration, policy coordination, unit labour costs
    Date: 2014–03
  2. By: Angelini, Elena; Ca' Zorzi, Michele; Forster, Katrin
    Abstract: A balanced current account in the euro area has disguised sizeable net lending imbalances at the country level, exposing the common currency area to severe pressures during the financial crisis. The key contribution of this paper is to evaluate the adjustment process through the lenses of the New Multi Country Model at the country and sectoral level. We find that shocks to the external, fiscal and monetary environment help explain, to a large degree, the sizeable current account adjustment and rise in unemployment in Spain. The model also suggests that a recovery in wage competitiveness helps to reduce external deficits at the cost of higher net borrowing by households. The stimulus effects on aggregate demand, via the interest rate response of the common monetary authority and the competitiveness channel, are present but not overly large, as the rebound in economic activity depends mainly on global demand, supportive monetary policy, business and consumer confidence. JEL Classification: C5, F32, F41, O52
    Keywords: current account, euro area countries, modeling, net lending
    Date: 2014–03
  3. By: Darracq Pariès, Matthieu; Maurin, Laurent; Moccero, Diego
    Abstract: We implement a two-step approach to construct a financing conditions index (FCI) for the euro area and its four larger member states (Germany, France, Italy and Spain). The method, which follows Hatzius et al. (2010), is based on factor analysis and enables to summarise information on financing conditions from a large set of financial indicators, controlling for the level of policy interest rates, changes in output and inflation. We find that the FCI tracks successfully both worldwide and euro area specific financial events. Moreover, while the national FCIs are constructed independently, they display a similar pattern across the larger euro area economies over most of the sample period and varied more widely since the start of the sovereign debt crisis in 2010. Focusing on the euro area, we then incorporate the FCI in a VAR model comprising output, inflation, the monetary policy rate, bank loans and bank lending spreads. The credit supply shock extracted with sign restrictions is estimated to have caused around one fifth of the decline in euro area manufacturing production at the trough of the financial crisis and a rise in bank lending spreads of around 30 basis points. We also find that adding the FCI to the VAR enables an earlier detection of credit supply shocks. JEL Classification: E17, E44, E50
    Keywords: credit supply shocks, euro area, factor models, financial conditions index, large dataset, sign restrictions, structural VAR
    Date: 2014–03
  4. 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 spill overs 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. JEL Classification: E44, F30, G15, C23, H63
    Keywords: bond spreads, CDS spreads, contagion, ratings, sovereign debt crisis, sovereign risk
    Date: 2013–12
  5. By: Iossifov, Plamen
    Abstract: In this paper, we highlight the role of global value chains in the synchronization of economic activity between countries in Central and Eastern Europe (CEE) and the euro area. We start off by demonstrating that the degree of synchronization of the business cycles of CEE countries and their main trade partners from the euro area has increased in recent years. We next show that the cyclical fluctuations of GDP in CEE countries are strongly influenced by pro-cyclical movements of changes in inventories. We then present evidence of the importance of cross border production chains for the economies of CEE countries. We build on these findings to show that the propagation of changes in demand for imports along global supply chains—linked to technological requirements and inventory stock adjustments—contributes to the synchronization of economic activity across Europe. We also show evidence that CEE exporters have started to set up their own value chains in the CEE region. JEL Classification: E32, F44, F62, O52
    Keywords: business cycle, CEE, Central and Eastern European countries, cross-border production chains, global value chains, inventories
    Date: 2014–01
  6. By: Philip Du Caju (National Bank of Belgium); Theodora Kosma (Bank of Greece); Martina Lawless (Central Bank of Ireland); Julian Messina (World Bank and Universitat de Girona); Tairi Room (Eesti Pank)
    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: 2014–01
  7. By: Conesa, Juan Carlos (Stony Brook University); Kehoe, Timothy J. (Federal Reserve Bank of Minneapolis)
    Abstract: In January 1995, U.S. President Bill Clinton organized a bailout for Mexico that imposed penalty interest rates and induced the Mexican government to reduce its debt, ending the debt crisis. Can the Troika (European Commission, European Central Bank, and International Monetary Fund) organize similar bailouts for the troubled countries in the Eurozone? Our analysis suggests that debt levels are so high that bailouts with penalty interest rates could induce the Eurozone governments to default rather than reduce their debt. A resumption of economic growth is one of the few ways that the Eurozone crises can end.
    Keywords: Sovereign debt; Bailout; Penalty interest rate; Collateral
    JEL: F34 F53 G01
    Date: 2014–02–05
  8. By: Beetsma, Roel; de Jong, Frank; Giuliodori, Massimo; Widijanto, Daniel
    Abstract: We use realised variances and co-variances based on intraday data from Eurozone sovereign bond market to measure the dependence structure of eurozone sovereign yields. Our analysis focuses on the impact of news, obtained from the Eurointelligence newsflash, on the dependence structure. More news raises the volatility of interest rates of financially distressed countries and decreases the covariance of distressed countries' yields with German bond yields, suggesting a flight-to-quality effect. Common news about the euro crisis and news about specific countries itself tend to raise the covariance of yields between distressed countries, indicating potential crisis spillover effects. However, we do not detect spillover effects from news about third countries to the covariance between other country pairs. Bond purchases by the ECB under its Securities Markets Programme (SMP) mitigate the negative crisis spillovers among the distressed countries and reduce the flight-to-safety from the distressed countries to Germany. JEL Classification: E62, G01, G12, G15, H63
    Keywords: crisis, eurozone, realized covariances, SMP, sovereign debt, spillovers
    Date: 2014–01
  9. By: Patricia Esteve-González & Bernd Theilen
    Abstract: In this paper we examine the influence of economic factors on partisan support for European integration over the last three decades. We find that partisan support is larger in ‘poorer’ countries with direct economic benefits from EU membership. On the other hand, parties in countries affected by the Maastricht criteria are more Euro-sceptical. We also find weak evidence for larger partisan support in countries with more developed welfare states, and that the support for European integration fluctuates in parallel with the business cycle. Finally, our results indicate that the importance of economic factors in determining partisan support for European integration has grown in recent periods.
    Keywords: Maastricht Treaty; budget; trade policy
    Date: 2014–02–05
  10. By: Renaud Thillaye; Ludek Kouba; Andreas Sachs
    Abstract: Despite significant measures to reinforce the EMU’s institutional set-up, there is widespread consensus that more needs to be done in order to better deal with cyclical and structural heterogeneity in the EU. Market-based adjustment mechanisms are necessary but not sufficient to advance convergence along more sustainable growth patterns. In that context, institutional reforms advancing integration in the Eurozone are often said to be desirable from an economic point of view, albeit fraught with political difficulties. This paper seeks to provide a fresh outlook on this debate by bringing forward a third, overlooked dimension, namely the feasibility, or ‘implementability’, of governance reforms. Like national technocracies, the EU faces the risk of failure whereby the creation of institutions or the introduction of new policies do not always bring about the expected outcomes. The paper develops a multi-criteria analytical framework to assess three possible innovations of economic governance: rule-based wage coordination, contractual arrangements for reforms, and a stabilisation fund for the Euro area. The ‘robustness’ of any proposal seeking to increase the EU’s interference into national policy-making should start with a clear economic justification, while taking the dynamics of national preferences into account. However, the risks of moral hazard and institutional barriers should also be systematically internalised in the assessment. After outlining the analytical framework (section 1), the paper assesses the three tentative reforms by using a wide range of data and analyses from existing EU documentation, academic and policy literature, and opinion surveys (sections 2 to 4). Each section ends with some recommendations on the desirable scope and design of reforms. Overall, the three case studies stress the need for a careful and reasoned approach to reforming EU governance. Beyond the predictable clash of economic rationales and political hurdles, reform ideas tend to overlook the difficulties arising at the implementation stage. Diverse wage-setting systems, low administrative capacities, and statistical uncertainty for instance all warn against ‘more EU money’ or ‘EU interference’. The paper, therefore, makes the case for experimental and small-scale innovations and for a much greater engagement of the public in the politics of EU coordination.
    Keywords: EU integration, European economic policy, European governance, European Monetary Union, Good governance, Institutional reforms, Labour markets, Macroeconomic disequilibria, Multi-level governance, Welfare reform
    JEL: E02
    Date: 2014–03
  11. By: Ghysels, Eric; Idier, Julien; Manganelli, Simone; Vergote, Olivier
    Abstract: Policy impact studies often suffer from endogeneity problems. Consider the case of the ECB Securities Markets Programme: If Eurosystem interventions were triggered by sudden and strong price deteriorations, looking at daily price changes may bias downwards the correlation between yields and the amounts of bonds purchased. Simple regression of daily changes in yields on quantities often give insignificant or even positive coefficients and therefore suggest that SMP interventions have been ineffective, or worse counterproductive. We use high frequency data on purchases of the ECB Securities Markets Programme and sovereign bond quotes to address the endogeneity issues. We propose an econometric model that considers, simultaneously, first and second conditional moments of market price returns at daily and intradaily frequency. We find that SMP interventions succeeded in reducing yields and volatility of government bond segments of the countries under the programme. Finally, the new econometric model is broadly applicable to market intervention studies. JEL Classification: E52, E44, G12, C58
    Keywords: component models, euro area crisis, high frequency data, SMP, unconventional monetary policy
    Date: 2014–02
  12. By: Thomas Conlon; John Cotter
    Abstract: To mitigate potential contagion from future banking crises, the European Commission recently proposed a framework which would provide for the $\textit{bail-in}$ of bank creditors in the event of failure. In this study, we examine this framework retrospectively in the context of failed European banks during the global financial crisis. Empirical findings suggest that equity and subordinated bond holders would have been the main losers from the 535 billion euro impairment losses realized by failed European banks. Losses attributed to senior debt holders would, on aggregate, have been proportionally small, while no losses would have been imposed on depositors. Cross-country analysis, incorporating stress-tests, reveals a divergence of outcomes with subordinated debt holders wiped out in a number of countries, while senior debt holders of Greek, Austrian and Irish banks would have required bail-in.
    Date: 2014–03
  13. By: Minoas Koukouritakis (University of Crete); Athanasios P. Papadopoulos (University of Crete); Andreas Yannopoulos (University of Crete)
    Abstract: In this paper, we investigate the monetary transmission mechanism through interest rate and real effective exchange rate channels, for five South-Eastern European countries, namely Bulgaria, Croatia, Greece, Romania and Turkey. Recent unit root and cointegration techniques in the presence of structural breaks in the data are used in the analysis. The empirical results validate the existence of a valid long-run relationship, with parameter constancy, for each of the five sample countries. Additionally, the estimated impulse response functions regarding the monetary variables and the real effective exchange rate converge and follow a reasonable pattern in all cases.
    Keywords: Monetary Transmission Mechanism; Structural Breaks; LM Unit Root Tests; Cointegration Tests; Impulse Responses.
    JEL: E43 F15 F42
    Date: 2014–01
  14. By: George T. Palaiodimos (Bank of Greece)
    Abstract: This article investigates by means of an augmented gravity model, the impact of EMU on financial market integration across time by assessing its effect on capital (equities and bonds) holdings. We contribute to the respective literature by investigating this effect from a global perspective and also investigate the case of a pre-EMU effect on both equity and bond markets. Furthermore, we focus on the potential impact of recent financial crisis on international equity and bond holdings. Our estimates indicate that intra-EMU integration effect improved in both equity and bond markets during the period close to the formation of EMU i.e. 1997, 2001 and 2002. In the case of the EMU equity market, this effect is mostly centered on 2001 (18% increase of EMU holdings) reflecting the beneficial impact of EMU and the introduction of the euro, while in the case of bond market this EMU effect is centered on 1997 (50%), reflecting the existence of pre-EMU integration effects. These integration effects have been also accompanied by increased demand from the side of non-EMU investors in both markets. Lastly, these integration effects weaken significantly after 2007, mainly reflecting a post-crisis disintegration of EMU capital markets both internally and globally. These findings may be regarded as a red flag over the current status quo within EMU which is characterized by low levels of integration. This finding provides support for a push for a new EMU architecture in the form of greater fiscal and financial integration and supervision. Only in this way will EMU become a true currency union.
    Keywords: Market integration; Gravity models; equity holdings; bond holdings; EMU.
    JEL: F36 F30 F10 F41 G11
    Date: 2013–12
  15. By: Anne Laure Delatte (Ofce sciences-po, Cnrs,Cepr; Neoma Business school, CGEMP LEDa Author-Name : Richard Portes; London Business School, CEPR)
    Abstract: Is the pricing of sovereign risk linear during bearish episodes? Or can initial shocks on economic fundamentals be exacerbated by endogenous factors that create nonlinearities? We test for nonlinearities in the sovereign bond market of European peripheral countries during the debt crisis and explain them. Our estimates based on a panel smooth threshold regression model during January 2006 to September 2012 show four main findings: 1)Peripheral sovereign spreads are subject to significant nonlinear dynamics. 2) he deterioration of market conditions for financial names changes the way investors price risk of the sovereigns. 3)The spreads of European peripheral countries have been priced above their historical values, given fundamentals, because of amplification effects. 4)Two CDS indices on financial names unambiguously stand out as leading drivers of these amplification effects.
    Keywords: European sovereign crisis, Panel Smooth Threshold regression models, CDS indices
    JEL: E44 F34 G12 H63 C23
    Date: 2014–03
  16. By: Ferrando, Annalisa; Marchica, Maria-Teresa; Mura, Roberto
    Abstract: We use a large database of more than 685,000 European firms to show that financial flexibility attained through conservative leverage policies is more important for private, small, medium-sized and young firms and for firms in countries with lower access to credit and weaker investor protection. Further, using the recent financial crisis as a natural experiment, we show that financial flexibility status allows companies to reduce the negative impact of liquidity shocks on their investment decisions. Our findings support the hypothesis that financial flexibility relates to companies’ ability to undertake future investment, despite market frictions hampering possible profitable growth opportunities. JEL Classification: G31, G32, D92
    Keywords: cross-country analysis, financial flexibility, investment, low leverage
    Date: 2014–01
  17. By: Nancy van Beers; Michiel Bijlsma; Gijsbert T. J. Zwart
    Abstract: Countries in a monetary union can adjust to shocks either through internal or external mechanisms. We quantitatively assess for the European Union a number of relevant mechanisms suggested by Mundellâ??s optimal currency area theory, and compare them to the United States. For this purpose, we update a number of empirical analyses in the economic literature that identify (1) the size of asymmetries across countries and (2) the magnitude of insurance mechanisms relative to similar mechanisms and compare results for the European Monetary Union (EMU) with those obtained for the US. To study the level of synchronization between EMU countries we follow Alesina et al. (2002) and Barro and Tenreyro (2007). To measure the effect of an employment shock on employment levels, unemployment rates and participation rates we perform an analysis based on Blanchard and Katz (1992) and Decressin and Fatas (1995). We measure consumption smoothing through capital markets, fiscal transfers and savings, using the approach by Asdrubali et al. (1996) and Afonso and Furceri (2007). To analyze risk sharing through a common safety net for banks we perform a rudimentary simulation analysis.
    Date: 2014–03
  18. By: Ampudia, Miguel; Ehrmann, Michael
    Abstract: This paper studies to what extent the experiences of households shape their willingness to take financial risks. It follows the methodology of Malmendier and Nagel (2011) and applies it to a novel data set on household finances covering euro area households. We show that experienced stock market returns matter in a statistically significant and economically substantial fashion: better experiences increase the financial risk households are willing to take as well as stock market participation along the intensive and the extensive margin. We find that more distant experiences receive a somewhat lower (but still substantial) weight than the corresponding findings suggest for the United States. Furthermore, there are additional effects stemming from the experience of extreme stock market downturns. Households in countries that witnessed a particularly severe 2008 stock market crash give substantially more weight to the most recent experience, suggesting that in these countries an even more pronounced underinvestment in the stock market should be expected in the years to come. The evidence highlights the relevance of personal experiences for household behaviour. JEL Classification: D03, D14, D83, G11
    Keywords: household finance, learning, portfolio choice, rare disasters, risk-taking behavior
    Date: 2014–03
  19. By: Afonso, António; Gomes, Pedro; Taamouti, Abderrahim
    Abstract: The reaction of EU bond and equity market volatilities to sovereign rating announcements (Standard & Poor’s, Moody’s, and Fitch) is investigated using a panel of daily stock market and sovereign bond returns. The parametric volatilities are filtered using EGARCH specifications. The estimation results show that upgrades do not have significant effects on volatility, but downgrades increase stock and bond market volatility. Contagion is present, with sovereign rating announcements creating interdependence among European financial markets with upgrades (downgrades) in one country leading to a decrease (increase) in volatility in other countries. The empirical results show also a financial gain and risk (value-at-risk) reduction for portfolio returns when taking into account sovereign credit ratings’ information for volatility modelling, with financial gains decreasing with higher risk aversion. JEL Classification: C22, C23, E44, G11, G15, H30
    Keywords: EGARCH, financial gain, optimal portfolio, risk management, sovereign ratings, stock market returns, value-at-risk, volatility, yields
    Date: 2014–03
  20. By: Bernhard Hammer; Alexia Prskawetz; Inga Freund
    Abstract: We investigate the reallocation of resources across age and gender in a comparative European setting. Our analysis is based on concepts and data from the National Transfer Accounts (NTA) project, as well as on data from income and time use surveys. We introduce the aggregate NTA life cycle deficit as a concept of an economic dependency ratio. This dependency measure allows for flexible age limits and age-specific levels of economic dependency. We then move beyond the current NTA methodology and study gender differences in the generation of income and extend our analysis by unpaid household work. We find large cross-country differences in the age- and gender-specific levels and type of production activities and consequently in the organisation of the resource reallocation across age. Our results clearly indicate that a reform of the welfare system needs to take into account not only public transfers but also private transfers, in particular the services produced within the households for own consumption (e.g. childcare, cooking, cleaning...).
    Keywords: Ageing, challenges for welfare system, demographic change, welfare state
    JEL: I38 J10
    Date: 2014–03

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