nep-eec New Economics Papers
on European Economics
Issue of 2015‒02‒05
eleven papers chosen by
Giuseppe Marotta
Università degli Studi di Modena e Reggio Emilia

  1. Interest Rates, Eurobonds and Intra-European Exchange Rate Misalignments: the Challenge of Sustainable Adjustments in the Eurozone. By Vincent Duwicquet; Jacques Mazier; Jamel Saadaoui
  2. Monetary policy, bank bailouts and the sovereign-bank risk nexus in the euro area By Fratzscher, Marcel; Rieth, Malte
  3. Systemic sovereign risk: macroeconomic implications in the euro area By Saleem A. Bahaj
  4. Drivers of Structural Change in Cross-Border Banking Since the Global Financial Crisis By Bremus, Franziska; Fratzscher, Marcel
  5. Youth Unemployment in Advanced Europe: Okun’s Law and Beyond By Angana Banerji; Hannah Huidan Lin; Sergejs Saksonovs
  6. It isn't just about Greece: domestic politics, transparency and fiscal gimmickry in Europe By James Alt; David Dreyer Lassen; Joachim Wehner
  7. Rebuilding Europe's Common Future: Combining Growth and Reform in the Euro Area By Adam S. Posen; Ajai Chopra; Angel Ubide; Paolo Mauro; Jacob Funk Kirkegaard; Nicolas Veron
  8. Differently unequal: Zooming-in on the distributional dimensions of the crisis in euro area countries By Marco D’Errico; Corrado Macchiarelli; Roberta Serafini
  9. The challenge of restoring debt sustainability in a deep economic recession: the case of Greece By Platon Monokroussos
  10. Banking Nationalism on the Road to Banking Union By Rachel A. Epstein; Martin Rhodes
  11. Does Supply or Demand Drive the Credit Cycle? Evidence from Central, Eastern, and Southeastern Europe By Greetje Everaert; Natasha Xingyuan Che; Nan Geng; Bertrand Gruss; Gregorio Impavido; Yinqiu Lu; Christian Saborowski; Jérôme Vandenbussche; Li Zeng

  1. By: Vincent Duwicquet; Jacques Mazier; Jamel Saadaoui
    Abstract: The euro zone crisis illustrates the deficiencies of adjustment mechanisms in a monetary union characterized by a large heterogeneity. Exchange rate adjustments being impossible, they are very few alternative mechanisms. At the level of the whole euro zone the euro is close to its equilibrium parity. But the euro is strongly overvalued for Southern European countries, France included, and largely undervalued for Northern European countries, especially Germany. The paper gives a new evaluation of these exchange rate misalignments inside the euro zone, using a FEER approach, and examines the evolution of competitiveness. In a second step, we use a two-country SFC model of a monetary union with endogenous interest rates and eurobonds issuance. Three main results are obtained. Facing a competitiveness loss in southern countries due to exchange rates misalignments, increasing intra-European financing by banks of northern countries or other institutions could contribute to reduce the debt burden and induce a partial recovery but public debt would increase. Implementation of eurobonds as a tool to partly mutualize European sovereign debt would have a rather similar positive impact, but with a public debt limited to 60% of GDP. Furthermore, eurobonds could also be used to finance large European projects which could impulse a stronger recovery in the entire euro zone with stabilized current account imbalances. However, the settlement of a European Debt Agency in charge of the issuance of the eurobonds would face strong political obstacles.
    Keywords: Eurozone Crisis, Sustainable Adjustments, Exchange Rate Misalignments, Eurobonds, Interest Rate.
    JEL: C23 F31 F32 F37 F41 E12
    Date: 2015
  2. By: Fratzscher, Marcel; Rieth, Malte
    Abstract: The paper analyses the empirical relationship between bank risk and sovereign credit risk in the euro area. Using structural VAR with daily financial markets data for 2003-13, the analysis confirms two-way causality between shocks to sovereign risk and bank risk, with the former being overall more important in explaining bank risk, than vice versa. The paper focuses specifically on the impact of non-standard monetary policy measures by the European Central Bank and on the effects of bank bailout policies by national governments. Testing specific hypotheses formulated in the literature, we find that bank bailout policies have reduced solvency risk in the banking sector, but partly at the expense of raising the credit risk of sovereigns. By contrast, monetary policy was in most, but not all cases effective in lowering credit risk among both sovereigns and banks. Finally, we find spillover effects in particular from sovereigns in the euro area periphery to the core countries.
    Keywords: bank bailout; banks; credit risk; heteroscedasticity; monetary policy; sovereigns; spillovers
    JEL: E52 E60 G10
    Date: 2015–01
  3. By: Saleem A. Bahaj
    Abstract: What are the macroeconomic implications of changes in sovereign risk premia? In this paper, I use a novel identification strategy coupled with a new dataset for the Euro Area to answer this question. I show that exogenous innovations in sovereign risk premia were an important driver of the economic dynamics of crisis-hit countries, explaining 30-50% of the forecast error of unemployment. I also shed light on the mechanisms through which this occurs. Fluctuations in sovereign risk premia explain 20-40% of the variance of private borrowing costs. Increases in sovereign risk result in substantial capital flight, external adjustment and import compression. In contrast, governments appear not to increase their primary balances in response to increases in sovereign risk. Identifying these causal effects involves isolating a source of fluctuations in sovereign borrowing costs exogenous to the economy in question. I address this problem by relying upon the transmission of country-specific events during the crisis in Europe to the sovereign risk premia in the remainder of the union. I construct a new dataset of critical events in foreign crisis-hit countries and I measure the impact of these events on yields in the economy of interest at an intraday frequency. An aggregation of foreign events serve as a proxy variable for structural innovations to the yield to identify shocks in a proxy SVAR. I extend this methodology into a Bayesian setting to allow for flexible panel assumptions. A counterfactual analysis is used to remove the impact of foreign events from the bond yields of crisis hit countries: I find that 40-60% of the trough-to-peak moves in bond yields in crisis-hit countries are explained by foreign events, thereby suggesting that the crisis was not purely a function of weak local economic conditions.
    Keywords: high frequency identification; narrative identification; contagion; Bayesian VARs; proxy SVARs; panel VAR
    JEL: E44 E65 F42
    Date: 2014–05
  4. By: Bremus, Franziska; Fratzscher, Marcel
    Abstract: The paper analyzes the effects of changes to regulatory policy and to monetary policy on cross-border bank lending since the global financial crisis. Cross-border bank lending has decreased, and the home bias in the credit portfolio of banks has risen sharply, especially among banks in the euro area. Our results suggest that expansionary monetary policy in the source countries – as measured by the change in reserves held at central banks - has encouraged cross-border lending, both in euro area and non-euro area countries. Regarding regulatory policy, increases in financial supervisory power or independence of the supervisory authorities have encouraged credit outflows from source countries. The findings thus underline the importance of regulatory arbitrage as a driver of cross-border bank flows since the global financial crisis. However, in the euro area, arbitrage in capital stringency was linked to lower cross-border lending since the crisis.
    Keywords: arbitrage; cross-border bank lending; financial integration; home bias; monetary policy; regulation
    JEL: F30 G11 G15 G28
    Date: 2014–12
  5. By: Angana Banerji; Hannah Huidan Lin; Sergejs Saksonovs
    Abstract: The crisis has intensified what was previously a chronic unemployment problem in Europe; youth unemployment is now at unprecedented highs in some European countries. This paper assesses the main drivers of youth unemployment in Europe. It finds that much of the increase in youth unemployment rates during the crisis can be explained by output dynamics and the greater sensitivity of youth unemployment to economic activity than adult unemployment. Labor market institutions also play a significant role in explaining the persistently high levels of youth unemployment, especially the tax wedge, minimum wages relative to the median wage, spending on active labor market policies, the opportunity cost of working (measured by the unemployment benefits), vocational training, and labor market duality. This suggests that policies to address youth unemployment should be comprehensive and country-specific, focused on reviving growth and advancing labor market reforms.
    Keywords: Unemployment;Europe;Euro Area;Labor market characteristics;Labor market institutions;Migrations;Business cycles;Developed countries;Youth employment, youth unemployment, Okun’s law, business cycle, labor market factors
    Date: 2015–01–21
  6. By: James Alt; David Dreyer Lassen; Joachim Wehner
    Abstract: This article analyzes the political origins of differences in adherence to the fiscal framework of the European Union (EU). It shows how incentives to use fiscal policy for electoral purposes and limited budget transparency at the national level, combined with the need to respond to fiscal rules at the supranational level, interact to systematically undermine the Economic and Monetary Union through the employment of fiscal gimmicks or creative accounting. It also explains in detail how national accounts were manipulated to produce electoral cycles that were under the radar of the EU budget surveillance system, and concludes with new perspectives on the changes to (and challenges for) euro area fiscal rules.
    JEL: N0
    Date: 2014–10
  7. By: Adam S. Posen (Peterson Institute for International Economics); Ajai Chopra (Peterson Institute for International Economics); Angel Ubide (Peterson Institute for International Economics); Paolo Mauro (Peterson Institute for International Economics); Jacob Funk Kirkegaard (Peterson Institute for International Economics); Nicolas Veron (Peterson Institute for International Economics)
    Abstract: Europe must adopt policies to grow and reform at the same time to reverse its downward economic slide, excessively low inflation, high unemployment, and the risk of a lost decade or more. Seven years after the start of the global financial crisis in 2007, the prospect of secular stagnation threatens to fracture the political and social fabric of the euro area. This PIIE Briefing of six essays by economists at the Peterson Institute for International Economics offers a roadmap for policymakers to guide Europe out of its current self-defeated policy mix. The main message of this volume is that monetary and fiscal policies must more actively work in tandem with productivity-enhancing structural reforms (such as deregulation and deepening the single market) to shift the euro area toward a path of higher growth and stable prices. The policies recommended here are well short of revolutionary, but they would replace the politically accepted but dangerous narrative of fiscal austerity, internal devaluation, and moral hazard, which has led to the current economic malaise.
    Date: 2014–12
  8. By: Marco D’Errico; Corrado Macchiarelli; Roberta Serafini
    Abstract: This paper discusses how income inequality developed during the current crisis in euro area countries, as well as the role played by each income source. Based on an extended definition of income – including additional components which do not appear in the standard Eurostat definitions – we complement the information provided by the Gini index and quantile ratios by computing an alternative inequality indicator, developed by Zenga (2007), and its decomposition by income source. While broadly confirming the distributional effect of the crisis documented in previous studies, we find that in specific countries the level of inequality appears higher when alternative measures are taken into account, and that the rise of inequality since 2008 has not been as modest as previous studies would suggest. The paper further looks at how the distribution of income has evolved during the crisis by income quantile groups (i.e. ‘zooming-in’). The results point to varying contribution of labour income in 2011 compared to 2007. In addition, while the impact of individual households’ characteristics shows a non-linear pattern across income quantile groups before the crisis, such dispersion has decreased in 2011. We argue that, on the basis of our analysis, not only euro area countries are “differently unequal” in that inequality has developed in a very peculiar way in different countries, but also that it needs to be tackled at a finer level of analysis.
    Keywords: inequality curve, income distribution, source decomposition, extended income definition, crisis
    Date: 2015–01
  9. By: Platon Monokroussos
    Abstract: The present paper studies the evolution of the Greek public debt ratio under different assumptions regarding the size and the degree of persistence of fiscal multiplies, the implementation profile of the applied fiscal adjustment and the response of financial markets to fiscal consolidation. The main results of our simulation exercise can be summarized as follows: a) taking into account Greece’s present debt ratio, a fiscal adjustment can lead to a contemporaneous increase in the ratio if the fiscal multiplier is higher than ca 0.5; b) despite the unprecedented improvement in the underlying fiscal position since 2010, the concomitant increase in the public debt ratio can be mainly attributed to its high initial level, a very wide initial structural deficit as well as the ensuing economic recession; c) notwithstanding its negative initial effects on domestic economic activity, the enormous fiscal effort undertaken over the last 5 years leaves the country’s debt ratio in a more sustainable path relative to a range of alternative scenarios assuming no adjustment or a more gradual implementati
    Keywords: Self-defeating consolidations; fiscal multiplier; public debt; Greece; European Commission
    JEL: N0
    Date: 2014–10
  10. By: Rachel A. Epstein; Martin Rhodes
    Abstract: European states have a long history of banking sector nationalism. Control over credit allocation is believed to contribute to economic development and competitiveness goals, insulation from external economic shocks, and control over monetary policy. This paper explains the potentially dramatic loss in domestic control over banks created by the European Banking Union (EBU). First, we argue that ongoing liberalization in the global and European economies has made banking sector protectionism both more costly and conflictual. Second, we contend that because many of the biggest banks have internationalized their operations, they now prefer centralized European regulation and supervision. Third, supporting a modified neofunctionalist argument, we find that behind the sometimes frenetic intergovernmental bargaining in 2012-14, it is primarily the European Commission and the European Central Bank that have pushed Banking Union ahead. Supranational institutions have argued, with some success, that they have unique capacity to solve collective action and prisoners’ dilemma problems. Contrary to accepted wisdom, Germany has not set or limited the Banking Union agenda to a great extent, in part because of its own internal divisions. Moreover, the Commission and the ECB have managed at critical junctures to isolate Germany to secure the country’s assent to controversial measures.
    Keywords: supranationalism; protectionism; regulation; fiscal policy; European Central Bank; European Commission
    Date: 2014–12–15
  11. By: Greetje Everaert; Natasha Xingyuan Che; Nan Geng; Bertrand Gruss; Gregorio Impavido; Yinqiu Lu; Christian Saborowski; Jérôme Vandenbussche; Li Zeng
    Abstract: Countries in Central, Eastern, and Southeastern Europe (CESEE) experienced a credit boom-bust cycle in the last decade. This paper analyzes the roles of demand and supply factors in explaining this credit cycle. Our analysis first focuses on a large sample of bank-level data on credit growth for the entire CESEE region. We complement this analysis by five case studies (Latvia, Lithuania, Montenegro, Poland, and Romania). Our results of the panel data analysis indicate that supply factors, on average and relative to demand factors, gained in importance in explaining credit growth in the post-crisis period. In the case studies, we find a similar result for Lithuania and Montenegro, but the other three case studies point to the fact that country experiences were heterogeneous.
    Date: 2015–01–23

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