nep-eec New Economics Papers
on European Economics
Issue of 2014‒07‒13
fourteen papers chosen by
Giuseppe Marotta
University of Modena and Reggio Emilia

  1. Transmission of Financial Stress in Europe: The Pivotal Role of Italy and Spain, but not Greece By Brenda González-Hermosillo; Christian A Johnson
  2. "When Good Intentions Pave the Road to Hell: Monetization Fears and Europe's Narrowing Options" By Andrea Terzi
  3. A Dynamic Yield Curve Model with Stochastic Volatility and Non-Gaussian Interactions: An Empirical Study of Non-standard Monetary Policy in the Euro Area By Geert Mesters; Bernd Schwaab; Siem Jan Koopman
  4. Real Unit Labour Costs in Eurozone Countries: Drivers and Clusters By Ordóñez, Javier; Sala, Hector; Silva, José I.
  5. Capital inflows and euro area long-term interest rates By Daniel Carvalho; Michael Fidora
  6. Credit rating agency downgrades and the Eurozone sovereign debt crises By Christopher F Baum; Margarita Karpava; Dorothea Schäfer; Andreas Stephen
  7. Sovereign CDS Spreads in Europe: The Role of Global Risk Aversion, Economic Fundamentals, Liquidity, and Spillovers By Frigyes F Heinz; Yan Sun
  8. Extra Government Debt in the Great Recession: All Intentional? By Riccardo Fiorito
  9. Euro or not Euro - that is not the question! Economic well-being and the fate of the European Monetary Union By Heise, Arne
  10. SMEs’ Access to Finance in the Euro Area: What Helps or Hampers? By Bahar Öztürk; Mico Mrkaic
  11. Price Level Changes and the Redistribution of Nominal Wealth Across the Euro Area By Adam, Klaus; Zhu, Junyi
  12. Sub-National Credit Risk and Sovereign Bailouts: Who Pays the Premium? By E. Jenkner; Zhongjin Lu
  13. Charting Ways Out of Europe’s Impasse – A Policy Memorandum By Francis Cripps; Michael Landesmann; Jacques Mazier; Robert McDowell; Terry McKinley; Pascal Petit; Terry Ward; Enrico Wolleb
  14. Structural Balance Targeting and Output Gap Uncertainty By Eugen Tereanu; Anita Tuladhar; Alejandro Simone

  1. By: Brenda González-Hermosillo; Christian A Johnson
    Abstract: This paper proposes a stochastic volatility model to measure sovereign financial distress. It examines how key European sovereign credit default swap (CDS) spreads affect each other; specifically, the paper analyses the volatility structure of Germany, Greece, Ireland, Italy, Spain and Portugal. The stability of Germany is a close proxy for the resilience of the euro area as markets use Germany’s sovereign CDS as a hedge for systemic risk. Although most of the CDS changes for Germany during 2009–12 were due to idiosyncratic factors, market developments in Italy and Spain contributed significantly, likely due to their relative importance in the region. Changes in Greece’s sovereign CDS had no significant effect on Germany’s sovereign CDS despite initial widespread concerns about such linkages. Spain and Italy show a notable co-dependence in explaining each other’s volatility while Germany also plays an important role. It is found that extreme bad news led to persistent and nearly permanent effects on the stochastic volatility of European sovereign CDS spreads.
    Keywords: Financial risk;Italy;Spain;Greece;Euro Area;Financial crisis;Spillovers;Global Financial Crisis 2008-2009;Economic models;Systemic Risk, Financial Crises, Volatility, Contagion, Credit Default Swaps
    Date: 2014–05–02
  2. By: Andrea Terzi
    Abstract: With the creation of the Economic and Monetary Union and the euro, the national government debt of eurozone member-states became credit sensitive. While the potentially destabilizing impact of adverse cyclical conditions on credit-sensitive debt was seriously underestimated, the design was intentional, framed within a Friedman-Fischer-Buchanan view that "no monetization" rules provide a powerful means to discipline government behavior. While most countries follow some kind of "no monetization" rule, the one embraced by the eurozone was special, as it also prevented monetization on the secondary market for debt. This made all eurozone public debt defaultable--at least until the European Central Bank (ECB) announced the Outright Monetary Transactions program, which can be seen as an enhanced rule-based approach that makes governments solvent on the condition that they balance their budgets. This has further narrowed Europe's options for policy solutions that are conducive to job creation. An approach that would require no immediate changes in the European Union's (EU) political structure would be for the EU to fund "net government spending in the interest of Europe" through the issue of a eurobond backed by the ECB.
    Keywords: Euro; Eurozone; Debt Monetization; Sovereign Debt Crisis; Government Budget Constraint
    JEL: E63 H63
    Date: 2014–06
  3. By: Geert Mesters (VU University Amsterdam, the Netherlands); Bernd Schwaab (European Central Bank); Siem Jan Koopman (VU University Amsterdam, the Netherlands)
    Abstract: We develop an econometric methodology for the study of the yield curve and its interactions with measures of non-standard monetary policy during possibly turbulent times. The yield curve is modeled by the dynamic Nelson-Siegel model while the monetary policy measurements are modeled as non-Gaussian variables that interact with latent dynamic factors, including the yield factors of level and slope. Yield developments during the financial and sovereign debt crises require the yield curve model to be extended with stochastic volatility and heavy tailed disturbances. We develop a flexible estimation method for the model parameters with a novel implementation of the importance sampling technique. We empirically investigate how the yields in Germany, France, Italy and Spain have been affected by monetary policy measures of the European Central Bank. We model the euro area interbank lending rate EONIA by a log-normal distribution and the bond market purchases within the ECB's Securities Markets Programme by a Poisson distribution. We find evidence that the bond market interventions had a direct and temporary effect on the yield curve lasting up to ten weeks, and find limited evidence that purchases changed the relationship between the EONIA rate and the term structure factors.
    Keywords: dynamic Nelson-Siegel models, Central bank asset purchases, non-Gaussian, state space methods, importance sampling, European Central Bank
    JEL: C32 C33 E52 E58
    Date: 2014–06–17
  4. By: Ordóñez, Javier (Universitat Jaume I de Castelló); Sala, Hector (Universitat Autònoma de Barcelona); Silva, José I. (University of Kent)
    Abstract: We examine the trajectories of the real unit labour costs (RULCs) in a selection of Eurozone economies. Strong asymmetries in the convergence process of the RULCs and its components – real wages, capital intensity, and technology – are uncovered through decomposition and cluster analyses. In the last three decades, the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) succeeded in reducing their RULCs by more than their northern partners. With the exception of Ireland, however, technological progress was weak; it was through capital intensification that periphery economies gained efficiency and competitiveness. Cluster heterogeneity, and lack of robustness in cluster composition, is a reflection of the difficulties in achieving real convergence and, by extension, nominal convergence. We conclude by outlining technology as the key convergence factor, and call for a renewed attention to real convergence indicators to strengthen the process of European integration.
    Keywords: real unit labour costs, Eurozone, real wages, capital intensity, technology
    JEL: F43 O47 O52
    Date: 2014–06
  5. By: Daniel Carvalho; Michael Fidora
    Abstract: Capital flows into the euro area were particularly large in the mid-2000s and the share of foreign holdings of euro area securities increased substantially between the introduction of the euro and the outbreak of the global financial crisis. We show that the increase in foreign holdings of euro area bonds in this period is associated with a reduction of euro area long-term interest rates by about 1.55 percentage points, which is in line with previous studies that document a similar impact of foreign bond buying on US Treasury yields. These results are relevant for understanding developments both in the euro area and abroad, as lower levels of long-term interest rates resulting from foreign accumulation of euro area debt securities may have added to increased risk appetite and hunt for yield at the global level.
    JEL: E43 E44 F21 F41 G15
    Date: 2014
  6. By: Christopher F Baum (Boston College; DIW Berlin); Margarita Karpava (MediaCom London); Dorothea Schäfer (DIW Berlin; JIBS); Andreas Stephen (JIBS; DIW Berlin; Ratio Institute Stockholm)
    Abstract: This paper studies of credit rating agency (CRA) downgrade 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 the 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 Gander causality from bond yields to rating announcement. We infer from these findings that CRA announcements increasingly influenced crisis-time capital allocation in the Eurozone. Their downgradings caused investors to rebalance their portfolio 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: 2014
  7. By: Frigyes F Heinz; Yan Sun
    Abstract: By analysing data from January 2007 to December 2012 in a panel GLS error correction framework we find that European countries’ sovereign CDS spreads are largely driven by global investor sentiment, macroeconomic fundamentals and liquidity conditions in the CDS market. But the relative importance of these factors changes over time. While during the 2008/09 crisis weak economic fundamentals (such as high current account decifit, worsening underlying fiscal balances, credit boom), a drop in liquidity and a spike in risk aversion contributed to high spreads in Central and Eastern and South-Eastern European (CESEE) countries, a marked improvement in fundamentals (e.g. reduction in fiscal deficit, narrowing of current balances, gradual economic recovery) explains the region’s resilience to financial market spillovers during the euro area crisis. Our generalised variance decomposition analyisis does not suggest strong direct spillovers from the euro area periphery. The significant drop in the CDS spreads between July 2012 and December 2012 was mainly driven by a decline in risk aversion as suggested by the model’s out of sample forecasts.
    Keywords: Sovereign debt;Europe;Euro Area;Spillovers;Capital markets;Liquidity;Economic models;debt threshold, current account, public debt, current account balance, debt crisis, global liquidity, debt sustainability, sovereign bonds, financial markets, debt restructuring, external financing, public finances, sovereign debt crisis, stock market volatility, international financial markets, external shock, financial sector, debt defaults, current account deficit, current account balances, sovereign default, budget balances, corporate bond
    Date: 2014–01–28
  8. By: Riccardo Fiorito (University of Siena)
    Abstract: Among the Great Recession costs there was the adoption of fiscal policies, generally bounded to increase government debt. In the Oecd area, however, the resulting debt jump was not simply due to counter-cyclical discretion, mostly because of two reasons: the first is that such policies were not always feasible, given the surveillance on the Eurozone countries. The second is the occurrence of an unusual nominal recession, increasing the debt-to-GDP ratio and affecting most Oecd economies in 2009 and the Euro periphery also later. Using a simple accounting scheme, the sources of the debt creation are evaluated during the 2008-13 crisis and the years immediately before (2000-07), comparing the US and the UK with the four biggest Eurozone countries. In general, deficits, inflation and real growth do not have the same role before or during the crisis. Differences are also found for countries pursuing, in special times, more counter-cyclical fiscal policies (US, UK but also Spain and France) and countries like Italy and, especially, Germany following more prudential lines: in one case, because of Italy’s limited fiscal space and, in the other, because of a predilection for stability that Germany maintained even during the most destabilizing, postwar, crisis
    Keywords: Government Debt, Recession, Nominal GDP
    JEL: E32 E62 E65
    Date: 2014
  9. By: Heise, Arne
    Abstract: It will be argued that it is not of fundamental importance for growth and employment whether the EU clings to the Euro or allows for a dissolution of the Eurozone and a reemergence of national currencies but how multi-level macroeconomic coordination of different policy areas and nation-states will be achieved. Given that this insight is based on an alternative economic reasoning which is (still) not the common view of most political and economic actors relevant in the EU, it will be analysed under which conditions it would be recommendable to maintain the Euro or to reestablish national currencies. --
    Keywords: european integration,neo-functionalism,neo-realism
    JEL: F15 P16
    Date: 2014
  10. By: Bahar Öztürk; Mico Mrkaic
    Abstract: The monetary transmission mechanism in the euro area has been adversely affected by the recent crises. Using survey data on thousands of euro area firms, we study factors that affect the access to finance of SMEs. We find that changes in bank funding costs and borrower leverage matter for firms’ access to finance. Increases in bank funding costs and borrowers’ debt-to-asset ratios are significantly and negatively associated with firms’ access to finance. The use of subsidies significantly improve access to finance of SMEs. Finally, access to finance is found to be positively related to firm size and firm age.
    Keywords: Access to capital markets;Euro Area;Monetary transmission mechanism;Private sector;Credit;Borrowing;Banking sector;Monetary policy;access to finance; micro, small and medium sized enterprises; monetary policy
    Date: 2014–05–09
  11. By: Adam, Klaus; Zhu, Junyi
    Abstract: We document the presence of sizable distributional effects from unexpected price level movements in the Euro Area (EA) using sectoral accounts and newly available data from the Household Finance and Consumption Survey. The EA as a whole is a net winner of unexpected price level increases, with Italy, Greece, Portugal and Spain being the biggest beneficiaries, and Belgium and Malta being the largest losers. Governments are net winners of inflation, while the household (HH) sector is a net loser in the EA as a whole. HHs in Belgium, Ireland, Malta and Germany incur the biggest per capita losses, while HHs in Finland and Spain turn out to be net winners of inflation. Considerable heterogeneity exists also within the HH sector: relatively young middle class HHs are net winners of inflation, while older and richer HHs are losers. As a result, wealth inequality in the EA decreases with unexpected inflation, although in some countries (Austria, Germany and Malta) inequality increases due to presence of relatively few young borrowing HHs. We document that HHs inflation exposure varies systematically across countries, with HHs in high inflation EA countries holding systematically lower nominal exposures.
    Keywords: inflation , redistribution , Euro Area , household survey
    JEL: E31 D31 D14
    Date: 2014
  12. By: E. Jenkner; Zhongjin Lu
    Abstract: Studies have shown that markets may underprice sub-national governments’ risk on the implicit assumption that these entities would be bailed out by their central government in case of financial difficulties. However, the question of whether sovereigns pay a premium on their own borrowing as a result of (implicitly or explicitly) guaranteeing sub-entities’ debt has been explored only little. We use an event study approach with separate equations for two levels of government to test for a simultaneous increase in sovereign risk premia and decrease in sub-national risk premia—or a de facto transfer of risk from the latter to the former—on the day a sovereign bailout is announced. Using daily financial market data for Spain and its autonomous regions from January 2010 to June 2013, we find support for our risk transfer hypothesis. We estimate that the Spanish sovereign’s spread may have increased by around 70 basis points as a result of the central government’s support for fiscally distressed comunidades autónomas.
    Keywords: Credit risk;Borrowing;Risk premium;Spain;Fiscal policy;sub-national public finances, sovereign risk premium, bailout, interest rates, bond, bond yields, bonds, financial sector, bond market, moral hazard, government bond, individual bond, hedging, financial market, bond spreads, liquidity support, bond prices, national bond, sovereign bond, hedges, rate bonds, sovereign bonds, national bond markets, credit derivatives, term bonds, interest rate risk, sub-national bond market, individual bonds, national bonds, municipal bond market, financial stability, government bond yields, coupon bonds, bond issuance, sovereign bond market, sub-national bonds
    Date: 2014–01–30
  13. By: Francis Cripps; Michael Landesmann (The Vienna Institute for International Economic Studies, wiiw); Jacques Mazier; Robert McDowell; Terry McKinley; Pascal Petit; Terry Ward; Enrico Wolleb
    Abstract: Summary The European Union has reached a critical juncture in dealing with the fallout from the 2008 financial meltdown that started in the USA and spread to engulf banks and the financial markets of Europe. The ensuing recession or stagnation in many member countries was compounded by austerity programs undertaken by national governments, in some cases as a pre-condition for rescue from potential bankruptcy. Europe’s leaders took initiatives to strengthen financial systems but have been unable to secure a significant recovery of the European economy or avert growing divergences between member states in GDP per capita, unemployment rates and external-account balances. This memorandum written by participants of a 3-year research project on Europe and the world’s socio-economic future to 2030 (the AUGUR project) discusses possible ways out of prolonged stagnation and low growth. The current trajectory can trigger renewed crises of political-economic sclerosis in Europe and progressively undermine social standards and well-being. Such an outcome would strengthen the forces that aim to dismantle European integration. An overriding priority must be given to rebalancing the distribution of growth between different parts of Europe. Policies in R&D, competition and external trade must be reassessed with these objectives in view. EU finance for social programmes in lower-income countries is needed to support improvements in education, health and other public services that benefit social cohesion thereby securing the foundation for higher productivity and competitiveness.
    Keywords: policy memorandum, Europe, European integration, location policies
    JEL: E02 E17 E27 E61 E63 E65 F01 F43 H12 I38
    Date: 2014–06
  14. By: Eugen Tereanu; Anita Tuladhar; Alejandro Simone
    Abstract: Potential output estimation plays a crucial role in conducting fiscal policy based on structural balances. Difficulties in estimating potential output could lead to an erroneous policy stance with a consequent impact on growth. This paper analyzes historical data on revisions of actual and potential growth in the European Union and the implication of these revisions for the measurement of fiscal effort using the cyclically-adjusted primary balance (CAPB). It finds that revisions in output gap estimates were large, at almost 1½ percent of potential GDP on average. Revisions in potential GDP also contributed significantly to revisions in the estimated CAPB, especially during the crisis years. Given these findings and historical correlations, it proposes an indicative rule of thumb for reducing errors in the measurement of fiscal effort by factoring in that about 30 percent of revisions in actual growth capture changes in potential growth. In other words, the standard advice of “letting automatic stabilizers operate fully†in response to a positive/negative growth shocks likely implies a strengthening/weakening of the structural position.
    Keywords: Structural fiscal balance;European Economic and Monetary Union;Fiscal policy;Economic growth;structural balance, cyclically adjusted balance, fiscal policy
    Date: 2014–06–13

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