nep-eec New Economics Papers
on European Economics
Issue of 2016‒06‒04
sixteen papers chosen by
Giuseppe Marotta
Università degli Studi di Modena e Reggio Emilia

  1. Fine-tuning the use of bail-in to promote a stronger EU financial system By Micossi, Stefano; Bruzzone, Ginevra; Cassella, Miriam
  2. Institutions and Growth in Europe By Masuch, Klaus; Moshammer, Edmund; Pierluigi, Beatrice
  3. Political Economy of EMU. Rebuilding Systemic Trust in the Euro Area in Times of Crisis By Felix Roth
  4. Euro, Crisis and Unemployment: Youth Patterns, Youth Policies? By Ghoshray, Atanu; Ordóñez, Javier; Sala, Hector
  5. Inflation anchoring in the euro area By Speck, Christian
  6. Euro area monetary and fiscal policy tracking design in the time-frequency domain By Crowley, Patrick M.; Hudgins, David
  7. Euro Area Sovereign Ratings: An Analysis of Fundamental Criteria and Subjective Judgement By Antonello D'Agostino; Rudolf Alvise Lennkh
  8. Robustness in Foreign Exchange Rate Forecasting Models: Economics-Based Modelling After the Financial Crisis By Carlos Medel; Gilmour Camilleri; Hsiang-Ling Hsu; Stefan Kania; Miltiadis Touloumtzoglou
  9. Did foreign banks “cut and run” or stay committed to Emerging Europe during the crises? By Bonin, John P.; Louie, Dana
  10. Are monetary unions more synchronous than non-monetary unions? By Crowley, Patrick M.; Trombley, Christopher
  11. Medium-Term Budgetary Frameworks in the EU Member States By Monika Sherwood
  12. When Bubble Meets Bubble: Contagion in OECD Countries By Jose Eduardo Gomez-Gonzalez; Juliana Gamboa-Arbeláez; Jorge Hirs-Garzón; Andrés Pinchao-Rosero
  13. Assessing the link between price and financial stability By Christophe Blot; Jérôme Creel; Paul Hubert; Fabien Labondance; Francesco Saraceno
  14. Fiscal Multipliers in the 21st century By Pedro brinca; Hans A. Holter; Per Krusell; Laurence Malafry
  15. Causality between credit depth and economic growth: Evidence from 24 OECD countries By Stolbov, Mikhail
  16. Does bank competition reduce cost of credit? Cross-country evidence from Europe By Fungáčová, Zuzana; Shamshur, Anastasiya; Weill, Laurent

  1. By: Micossi, Stefano; Bruzzone, Ginevra; Cassella, Miriam
    Abstract: This paper discusses the application of the new European rules for burden-sharing and bail-in in the banking sector, in view of their ability to accommodate broader policy goals of aggregate financial stability. It finds that the Treaty principles and the new discipline of state aid and the restructuring of banks provide a solid framework for combating moral hazard and removing incentives that encourage excessive risk-taking by bankers. However, the application of the new rules may have become excessively attentive to the case-by-case evaluation of individual institutions, while perhaps losing sight of the aggregate policy needs of the banking system. Indeed, in this first phase of the banking union, while large segments of the EU banking sector still require a substantial restructuring and recapitalisation, the market may not be able to provide all the needed resources in the current environment of depressed profitability and low growth. Thus, a systemic market failure may be making the problem impossible to fix without resorting to temporary public support. But the risk of large write-offs of capital instruments due to burden-sharing and bail-in may represent an insurmountable obstacle to such public support as it may set in motion an investors’ flight. The paper concludes by showing that existing rules do contain the flexibility required to accommodate aggregate policy requirements in the general interest, and outlines a public support scheme for the precautionary recapitalisation of solvent banks that would be compliant with EU law.
    Date: 2016–04
  2. By: Masuch, Klaus; Moshammer, Edmund; Pierluigi, Beatrice
    Abstract: This paper provides empirical evidence in support of the view that the quality of institutions is an important determinant of long-term growth of European countries. When also taking into account the initial level of GDP per capita and government debt, cross-country institutional differences can explain to a great extent the relative long-term GDP performance of European countries. It also shows that an initial government debt level above a threshold (e.g. 60-70%) coupled with institutional quality below the EU average tends to be associated with particularly poor long-term real growth performance. Interestingly, the detrimental effect of high debt levels on long-term growth seems cushioned by the presence of very sound institutions. This might be because good institutions help to alleviate the debt problem in various ways, e.g. by ensuring sufficient fiscal consolidation in the longer-run, allowing for better use of government expenditures and promoting sustainable growth, social fairness and more efficient tax administration. The quality of national institutions seems to enhance the long-term GDP performance across a large sample of countries, also including OECD countries outside Europe. The paper offers some evidence that, in the presence of good institutions, conditions for catching-up seem generally good also for euro-area and fixed exchange rate countries. Looking at sub-groupings, it seems that sound institutions may be particularly important for long-term growth in the countries where the exchange rate tool is no longer available (and where also sovereign debt is high), and less so in the countries with flexible exchange rate regimes. However, this result is preliminary and requires further research. The empirical findings on the importance of institutions are robust to various measures of output growth, different measures of institutional indicators, different sample sizes, different country groupings and to the inclusion of additional control variables. Overall, the results tend to support the call for structural reforms in general and reforms enhancing the efficiency of public administration and regulation, the rule of law and the fight against rent-seeking and corruption in particular.
    Date: 2016–04
  3. By: Felix Roth
    Abstract: This paper revisits the existent empirical evidence of a decline in citizens’ systemic trust in times of crisis for a 12-country sample of the euro area (EA12) from 1999 to 2014. They affirm a pronounced decline in trust in the periphery countries of the EA12, leading to particular low levels in the national government and parliament in Spain and Greece. They discuss the consequences of this decline for the political economy of Economic and Monetary Union and corroborate the strong and negative association between unemployment and trust. They provide evidence of the increase in unemployment in Spain and examine policy measures at the national and EU level to tackle unemployment. They revisit the evidence of the enduring support for the euro and discuss its relevance to crisis management. They elaborate upon the question of how to restore systemic trust without and with treaty change.
    JEL: C23 D72 E24 E42 E65 F50 G01 J0 O4 O52 Z13
    Date: 2015–09
  4. By: Ghoshray, Atanu (Newcastle University); Ordóñez, Javier (Universitat Jaume I de Castelló); Sala, Hector (Universitat Autònoma de Barcelona)
    Abstract: This paper examines the occurrence of structural breaks in European unemployment associated with major events experienced by the European economies at an institutional level: the creation of the European and Monetary Union (EMU) in 1999, and the Euro/financial crisis in 2008-2009, which was followed by a general and intensive reform process in the years afterwards. Beyond the well documented asymmetries across countries, we uncover different responses of adult and youth unemployment rates. While adult unemployment is more prone to experience structural breaks, youth unemployment is more sensitive to business cycle oscillations. This has been especially so in the recent crisis and calls for fine tuning policy measures specifically targeted to youth unemployed in bad times. One important implication of our findings is that generic labour market reforms are not effective enough to solve the youth unemployment problem across Europe. We point to educational policies that raise average qualifications and help school-to-work transitions as suitable complementary cures.
    Keywords: unemployment, structural breaks, crisis, Eurozone, youth, education
    JEL: J64 O52 J08 F66
    Date: 2016–05
  5. By: Speck, Christian
    Abstract: Did the decline in inflation rates from 2012 to 2015 and the low levels of market-based inflation expectations lead to de-anchored inflation dynamics in the euro area? This paper is the first time-varying event study to investigate the reaction of inflation-linked swap (ILS) rates - a market-based measure of inflation expectations - to macroeconomic surprises in the euro area. Compared to the pre-crisis period, surprises have a much stronger effect on spot ILS rates during the crisis. Medium-term forward ILS rates remain insensitive to news most of the time, which implies inflation anchoring. Only short periods of sensitivity on the part of medium-term forward ILS rates are identified at times of low inflation or recession. The sensitivity is lower over more distant forecast horizons such that medium-term sensitivity represents an inflation adjustment process and provides evidence for a de-anchoring of inflation expectations or a loss of credibility for the Eurosystem's policy target.
    Keywords: Inflation Anchoring,Inflation Expectations,Inflation-Linked Swaps,Event Study,Central Banking
    JEL: E31 E44 G12 G14
    Date: 2016
  6. By: Crowley, Patrick M.; Hudgins, David
    Abstract: This paper first applies the MODWT (Maximal Overlap Discrete Wavelet Transform) to Euro Area quarterly GDP data from 1995 – 2014 to obtain the underlying cyclical structure of the GDP components. We then design optimal fiscal and monetary policy within a large state-space LQ-tracking wavelet decomposition model. Our study builds a MATLAB program that simulates optimal policy thrusts at each frequency range where: (1) both fiscal and monetary policy are emphasized, (2) only fiscal policy is relatively active, and (3) when only monetary policy is relatively active. The results show that the monetary authorities should utilize a strategy that influences the short-term market interest rate to undulate based on the cyclical wavelet decomposition in order to compute the optimal timing and levels for the aggregate interest rate adjustments. We also find that modest emphasis on active interest rate movements can alleviate much of the volatility in optimal government spending, while rendering similarly favorable levels of aggregate consumption and investment. This research is the first to construct joint fiscal and monetary policies in an applied optimal control model based on the short and long cyclical lag structures obtained from wavelet analysis.
    Keywords: discrete wavelet analysis, euro area, fiscal policy, LQ tracking, monetary policy, optimal control
    JEL: C49 C61 C63 C88 E52 E61
    Date: 2015–08–12
  7. By: Antonello D'Agostino; Rudolf Alvise Lennkh (European Stability Mechanism)
    Abstract: This paper studies the sovereign ratings of the current 19 euro area Member States from 2005 to 2015. It disentangles the rating drivers into a ‘fundamental’ and ‘subjective’ component using Moody’s methodology, and explores which variables explain the ‘subjective’ component, that is Moody’s judgement. The main results show that judgement is applied to varying degrees, both across countries and over time. We find that past judgement as well as the 10-year government yield spread to the Bund are accurate predictors of the ‘subjective’ rating component. Our results suggest that Credit Rating Agencies should increase their methodological transparency and publish two ratings for each sovereign issuer, namely, i) a quantifiable, ‘fundamental’ rating which policymakers and market participants can replicate, and ii) a final rating, which includes agencies’ judgement.
    Keywords: Credit rating agencies, sovereign risk, sovereign ratings, euro area crisis
    JEL: F34 G15 G24 H63
    Date: 2016–05
  8. By: Carlos Medel; Gilmour Camilleri; Hsiang-Ling Hsu; Stefan Kania; Miltiadis Touloumtzoglou
    Abstract: Exchange rates (FX) typically measures structural misalignments anticipating future short-run dynamics of key macroeconomic variables aiming to correct those misalignments with or without external intervention. The aim of this article is to analyse the out-of-sample behaviour of a bunch of statistical and economics-based models when forecasting FX for the UK, Japan, and the Euro Zone in relation to the US, emphasising the commodity prices boom of 2007-8 and the financial crisis of 2008-9. We analyse the forecasting behaviour of six economic plus three statistical models when forecasting from one up to 60-steps-ahead, comprising from 1981.1 to 2014.6. Our six economicsbased models can be classified in three groups: interest rate spreads, monetary fundamentals, and purchasing power parity with global measures, covering a wide range of macroeconomic indicators. Our results indicate that there are changes of the best models when considering different time spans. In particular, interest-rate-based models tend to be better at predicting before 2008, also showing a better tracking when crisis hit. However, when considering until 2014, the models based on price differentials are more promising, but subject to heterogeneity across countries. These results are important since shed some light on what model specification use and combine when forecast facing different FX volatility.
    Date: 2016–05
  9. By: Bonin, John P.; Louie, Dana
    Abstract: Our objective is to examine empirically the behavior of foreign banks regarding real loan growth during a financial crisis for a set of countries in which these banks dominate the banking sectors due primarily to having taken over large existing former state-owned banks. The eight countries are among the most developed in Emerging Europe, their banking sectors having been modernized by the beginning of the time period.We consider a data period that includes an initial credit boom (2004 – 2007) followed by the global financial crisis (2008 & 2009) and the onset of the Eurozone crisis (2010). Our main innovations with respect to the existing literature on banking during the financial crisis are to include explicit consideration of exchange rate dynamics and to separate foreign banks into two categories, namely, subsidiaries of the Big 6 European MNBs and all other foreign-controlled banks. Our results show that bank lending was impacted adversely by the crisis but that the two types of foreign banks behaved differently. The Big 6 banks remained committed to the region in that their lending behavior was not different from that of domestic banks corroborating the notion that these countries are a “second home market” for these banks. Contrariwise, the other foreign banks were primarily responsible for fueling the credit boom prior to the crisis but then “cut and ran” by decreasing their lending appreciably during the crisis. Our results also indicate different bank behavior in countries with flexible exchange rate regimes from those in the Eurozone. Hence, we conclude that both innovations matter in empirical work on bank behavior during a crisis in the region and may, by extension, be relevant to other small countries in which banking sectors are dominated by foreign financial institutions.
    Keywords: foreign bank lending, financial crisis, multinational banks, Emerging Europe
    JEL: P34 G01 G15
    Date: 2015–11–04
  10. By: Crowley, Patrick M.; Trombley, Christopher
    Abstract: Within currency unions, the conventional wisdom is that there should be a high degree of macroeconomic synchronicity between the constituent parts of the union. But this conjecture has never been formally tested by comparing sample of monetary unions with a control sample of countries that do not belong to a monetary union. In this paper we take euro area data, US State macro data, Canadian provincial data and Australian state data — namely real Gross Domestic Product (GDP) growth, the GDP deflator growth and unemployment rate data — and use techniques relating to recurrence plots to measure the degree of synchronicity in dynamics over time using a dissimilarity measure. The results show that for the most part monetary unions are more synchronous than non-monetary unions, but that this is not always the case and particularly in the case of real GDP growth. Furthermore, Australia is by far the most synchronous monetary union in our sample.
    Keywords: business cycles, growth cycles, frequency domain, optimal currency area, macroeconomic synchronization, monetary policy, single currency
    JEL: C49 E32 F44
    Date: 2015–07–31
  11. By: Monika Sherwood
    Abstract: Effective budgetary management requires medium-term planning, by which the horizon for fiscal policymaking is extended beyond the annual budget cycle. All EU Member States have some sort of a Medium-Term Budgetary Framework (MTBF) in place but these frameworks differ substantially across countries in terms of political commitment, planning horizon, coverage, level of detail, formulation of targets, exclusion of certain items, carryover arrangements and binding nature. The experience of the recent crisis shows that allowing for more flexibility in the design of the MTBFs might be warranted. This, however, should be accompanied by more transparency in adjusting of the budgetary targets and increased role for independent monitoring of government's fiscal policy and execution.
    JEL: H50 H60
    Date: 2015–12
  12. By: Jose Eduardo Gomez-Gonzalez (Banco de la República de Colombia); Juliana Gamboa-Arbeláez (Banco de la República de Colombia); Jorge Hirs-Garzón (Banco de la República de Colombia); Andrés Pinchao-Rosero (Banco de la República de Colombia)
    Abstract: We study the existence and international migration of housing market bubbles, using quarterly information of twenty OECD countries for the period comprised between 1970 and 2015. We find that housing bubbles are present in all the countries included in our sample. Multiple bubbles are found in all but two of the countries included in our sample. We found ten episodes of migration. All of them had origin in the US housing bubble preceding the subprime crisis. Most migrations were to European countries. Notably, the Spanish housing bubble was not a direct consequence of the US housing bubbles. Its origin must be found in other causes. Classification JEL: G01; G12; C22
    Keywords: Housing bubbles, International migration of bubbles, Recursive right-tailed unit root tests.
    Date: 2016–05
  13. By: Christophe Blot (OFCE); Jérôme Creel (OFCE); Paul Hubert (OFCE); Fabien Labondance (OFCE (OFCE)); Francesco Saraceno (OFCE)
    Abstract: This paper aims at investigating first, the (possibly time-varying) empirical relationship between price and financial stability, and second, the effects of some macro and policy variables on this relationship in the United States and the Eurozone. Three empirical methods are used to examine the relevance of A.J. Schwartz's “conventional wisdom” that price stability would yield financial stability. Using simple correlations and VAR and Dynamic Conditional Correlations, we reject the hypotheses that price stability is positively correlated with financial stability and that the correlation is stable over time. The latter result and the analysis of the determinants of the link between price stability and financial stability cast some doubt on the appropriateness of the “leaning against the wind” monetary policy approach.
    Keywords: Price stability; Financial stability; DCC-GARCH; VAR
    JEL: C32 E31 E44 E52
    Date: 2015–02
  14. By: Pedro brinca (Nova School of Business and Economics, Universidade Nova de Lisboa, Portugal; Centro de Economia e Finanças, Universidade do Porto, Portugal; Robert Schuman Centre for Advanced Studies, European University Institute, Italy); Hans A. Holter (Department of Economics, University of Oslo, Norway); Per Krusell (Institute for International Economic Studies, Stockholm University, Sweden); Laurence Malafry (Department of Economics, Stockholm University, Sweden)
    Abstract: Fiscal multipliers appear to vary greatly overtime and space. Based on VARs for a large number of countries, we document a strong correlation between wealth inequality and the magnitude of fiscal multipliers. In an attempt to account for this finding, we develop a life-cycle, overlapping generations economy with uninsurable labor market risk. We calibrate our model to match key characteristics of a number of OECD economies, including the distribution of wages and wealth, social security, taxes, and government debt and study how a fiscal multiplier depends on various country characteristics. We find that the fiscal multiplier is highly sensitive to the fraction of the population who face binding credit constraints and also to the average wealth level in the economy. These findings together help us generate across-country pattern of multipliers that is quite similar to that in the data.
    Keywords: Fiscal multipliers, Wealth inequality, Government spending, Taxation
    JEL: E62 H21
    Date: 2015–09
  15. By: Stolbov, Mikhail
    Abstract: Causality between the ratio of domestic private credit to GDP and growth in real GDP per capita is investigated in a country-by-country time-series framework for 24 OECD economies over the period 1980–2013. The proposed threefold methodology to test for causal linkages integrates (i) lag-augmented VAR Granger causality tests, (ii) Breitung-Candelon causality tests in the frequency domain, and (iii) testing for causal inference based on a fully modified OLS (FMOLS) approach. For 12 of 24 countries in the sample, the three tests yield uniform results in terms of causality presence (absence) and direction. Causality running from credit depth to economic growth is found for the UK, Australia, Switzerland, and Greece. The findings lend no support to the view that financial development shifts from a supply-leading to demand-following pattern as economic development proceeds. The aggregate results mesh well with the current discussion on “too much finance” and disintermediation effects. However, idiosyncratic country determinants also appear significant.
    Keywords: causality, economic growth, financial development, FMOLS, frequency domain
    JEL: C22 E44 G21 O16
    Date: 2015–04–30
  16. By: Fungáčová, Zuzana; Shamshur, Anastasiya; Weill, Laurent
    Abstract: Despite the extensive debate on the effects of bank competition, only a handful of single-country studies deal with the impact of bank competition on the cost of credit. We contribute to the literature by investigating the impact of bank competition on the cost of credit in a cross-country setting. Using a panel of firms from 20 European countries covering the period 2001–2011, we consider a broad set of measures of bank competition, including two structural measures (Herfindahl-Hirschman index and CR5), and two non-structural indicators (Lerner index and H-statistic). We find that bank competition increases the cost of credit and observe that the positive influence of bank competition is stronger for smaller companies. Our findings accord with the information hypothesis, whereby a lack of competition incentivizes banks to invest in soft information and conversely increased competition raises the cost of credit. This positive impact of bank competition is however influenced by the institutional and economic framework, as well as by the crisis.
    Keywords: bank competition, bank concentration, cost of credit
    JEL: G21 L11
    Date: 2016–03–30

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