nep-eec New Economics Papers
on European Economics
Issue of 2016‒07‒16
twenty papers chosen by
Giuseppe Marotta
Università degli Studi di Modena e Reggio Emilia

  1. Stressed interbank markets: evidence from the European financial and sovereign debt crisis By Frutos, Juan Carlos; Garcia-de-Andoain, Carlos; Heider, Florian; Papsdorf, Patrick
  3. Labour Mobility and Labour Market Adjustment in the EU By Alfonso Arpaia; Aron Kiss; Balazs Palvolgyi; Alessandro Turrini
  4. Structural Breaks in Potential GDP Of Three Major Economies: Just Impaired Credit or the “New Normal”? By Alexander Yu. Apokin; Irina B. Ipatova
  5. “Debt-growth linkages in EMU across countries and time horizons” By Simón Sosvilla-Rivero; Marta Gómez-Puig
  6. EAGLE-FLI. A macroeconomic model of banking and financial interdependence in the euro area By Bokan, Nikola; Gerali, Andrea; Gomes, Sandra; Jacquinot, Pascal; Pisani, Massimiliano
  7. Financial stress transmission in EMU sovereign bond market volatility: A connectedness analysis By Fernando Fernández-Rodríguez; Marta Gómez-Puig; Simón Sosvilla-Rivero
  8. Volatility spillovers in EMU sovereign bond markets By Fernando Fernández-Rodríguez; Marta Gómez-Puig; Simón Sosvilla-Rivero
  9. Correlation and coordination risk By Martin Geiger; Richard Hule
  10. The pricing of sentiment risk in European stock markets By Keiber, Karl Ludwig; Samyschew, Helene
  11. Lifetime-Laffer Curves and the Eurozone Crisis By Zachary Stangebye
  12. Developing and emerging countries as finance providers; foreign exchange reserves and foreign direct investment to the European Union By Bruno Bonizzi; Jan Toporowski
  13. The scope and nature of privatisation in the financial sector By Janusz J. Tomidajewicz
  14. Are critical slowing down indicators useful to detect financial crises? By Hayette Gatfaoui; Isabelle Nagot; Philippe de Peretti
  15. Does uncertainty affect non-response to the European Central Bank's survey of professional forecasters? By López-Pérez, Víctor
  16. Making sense of the EU wide stress test: a comparison with the SRISK approach By Homar, Timotej; Kick, Heinrich; Salleo, Carmelo
  17. Heterogeneity of households and the effects of fiscal policy in CEE countries By Piotr Krajewski
  18. Self-fulfilling Prophecies in Sovereign Debt Markets By Nicolini, Juan Pablo
  19. Fiscal Implications of Central Bank Balance Sheet Policies By Orphanides, Athanasios
  20. The (Unintended?) Consequences of the Largest Liquidity Injection Ever By Miguel Faria-e-Castro; Luis Fonseca; Matteo Crosignani

  1. By: Frutos, Juan Carlos; Garcia-de-Andoain, Carlos; Heider, Florian; Papsdorf, Patrick
    Abstract: This paper documents stress in the unsecured overnight interbank market in the euro area over the course of the financial and sovereign debt crisis in Europe. We find that stress i) leads some banks to borrow in the market at rates that are higher than the rate of the marginal lending facility of the ECB, ii) leads to less cross-border transactions and contributes to the fragmentation of the euro area money market. A triple-difference estimate shows that the borrowing of banks in the periphery from banks in the core almost disappears in the second half of 2011. Domestic borrowing, however, replaces the loss of cross-border borrowing. Our findings document the severe malfunctioning of the market for liquidity caused by asymmetric information problems in crisis times. We exploit euro area payments data to construct a novel dataset of interbank lending and borrowing. We verify the validity of our approach using the post-trading structure MID, maintained at Banco de España. Based on our results, we conclude that MID is a very high quality source of Spanish interbank market data for research and policy purposes. JEL Classification: G01, G21, E58, F36
    Keywords: European sovereign debt crisis, financial crisis, Furfine algorithm, interbank markets, payment systems
    Date: 2016–06
  2. By: Elisabetta Montanaro (Ragnar Nurkse School of Innovation and Governance, Tallinn University of Technology)
    Abstract: The EU’s institutional architecture for financial regulation, based upon the principles of decentralisation across countries, segmentation across sectors, and voluntary cooperation among national regulators was clearly unsuitable to deal with overall financial stability risks arising from the internationalisation and conglomeration of financial firms. Oppositions to a true European arrangement for burden-sharing, and potential distributional consequences in the event of a crisis of a cross border bank have been the main hurdle to centralisation at European-level financial supervision. At the same time, the objective to create a levelled playing field in the EU single market has been always considered the necessary condition to promote the openness of national financial markets and cross-border banking. The paper aims to demonstrate that, since a single EU financial regulator in a multi-currency area is definitely a no viable alternative, the banking union’s design is just a partial solution for financial stability problems arising from the fragmentation of the single market in the event of idiosyncratic or systemic banking crises. The analysis performed on non-euro countries’ assessments of the pros and cons in joining the banking union clearly shows that until the fiscal responsibility for financial stability remains at the national level, the regulatory centralisation at the EU level cannot severe the traditional divide between home and host supervisors.
    Keywords: EU financial regulation; banking union; non-euro countries; CEE countries; cross-border banking
    JEL: F35 F65 G01 G28
    Date: 2016–01–30
  3. By: Alfonso Arpaia (European Commission); Aron Kiss (European Commission); Balazs Palvolgyi (European Commission); Alessandro Turrini (European Commission, IZA and Centro Studi Luca d'Agliano)
    Abstract: This paper assesses macroeconomic determinants of labour mobility and its role in the adjustment to asymmetric shocks. First, the paper develops stylised facts of mobility at the national and sub-national levels in the EU. Then, it explores the macroeconomic determinants of bilateral migration flows. Econometric evidence suggests that labour mobility increases significantly when a country joins the EU. While euro area membership seems not to be associated with an overall rise in the magnitude of mobility flows, workers do appear more ready to move from countries where unemployment is high to those where it is lower. Thirdly, the paper looks at mobility as a channel of economic adjustment by means of a VAR analysis in the vein of Blanchard and Katz (1992). Results indicate that mobility absorbs about a quarter of an asymmetric shock within 1 year. Movements in response to shocks have almost doubled since the introduction of the euro. Real wages have also become more responsive to asymmetric shocks during the same period.
    Keywords: Labour mobility; geographic mobility; migration; gravity; adjustment; asymmetric shocks; optimal currency areas; European Union
    JEL: J61 J64
    Date: 2016–06–10
  4. By: Alexander Yu. Apokin (National Research University Higher School of Economics); Irina B. Ipatova (National Research University Higher School of Economics)
    Abstract: This paper investigates the factors behind the recent growth slowdown (so-called Secular Stagnation) in the US, the euro area and Japan using the metrics of potential output growth. Specifically, our results offer limited support for an impaired credit transmission channel hypothesis (Reinhart and Rogoff, 2009a), while not supporting a supply slowdown hypothesis (Gordon, 2012). We propose a unified framework to test those hypotheses based on structural break tests of potential output. We estimate a variety of potential output growth models accounting for inflation, unemployment, and private credit dynamics (finance-neutral estimates) with multivariate Kalman filters and subject our estimates to structural break tests. We detect structural breaks between 2008 and 2010 for all three countries with Bai-Perron search procedure, the result being robust to the model specification and sample choice, with no significant difference between ordinary and finance-neutral estimates. We proceed with the Chen-Liu test to detect negative temporary change outliers in the Great Recession for the US and the euro area and negative level shift outliers for Japan. Moreover, original breaks in the Chen-Liu test disappear in the US and the euro area once we account for private credit and labour market dynamics, but do not change for Japan.
    Keywords: New Normal, Secular Stagnation, Great Slump, potential GDP, Kalman filter, Bai-Perron test, Chen-Liu test
    JEL: C53 E17 F44 O57
    Date: 2016
  5. By: Simón Sosvilla-Rivero (AQR Research Group-IREA. University of Barcelona); Marta Gómez-Puig (Complutense Institute for International Studies, University Complutense of Madrid)
    Abstract: This paper contributes to the literature by empirically examining whether the influence of public debt on economic growth differs between the short and the long run and presents different patterns across euro-area countries. To this end, we use annual data from both central and peripheral countries of the European Economic and Monetary Union (EMU) for the 1960-2012 period and estimate a growth model augmented for public debt using the Autoregressive Distributed Lag (ARDL) bounds testing approach. Our findings tend to support the view that public debt always has a negative impact on the long-run performance of EMU countries, whilst its short-run effect may be positive depending on the country.
    Keywords: Public debt, economic growth, bounds testing, euro area, peripheral EMU countries, central EMU countries. JEL classification: C22; F33; H63; O40; O52
    Date: 2016–04
  6. By: Bokan, Nikola; Gerali, Andrea; Gomes, Sandra; Jacquinot, Pascal; Pisani, Massimiliano
    Abstract: We incorporate financial linkages in EAGLE, a New Keynesian multi-country dynamic general equilibrium model of the euro area (EA) by including financial frictions and country-specific banking sectors. In this new version of the model, termed EAGLE-FLI (Euro Area and GLobal Economy with Financial LInkages), banks collect deposits from domestic households and cross- country interbank market and raise capital to finance loans issued to domestic households and firms. In order to borrow from local (regional) banks, households use domestic real estate as collateral whereas firms use both domestic real estate and physical capital. These features – together with the full characterization of trade balance and real exchange rate dynamics and with a rich array of financial shocks – allow to properly assess domestic and cross-country macroeconomic effects of financial shocks. Our results support the views that (1) the business cycles in the EA can be driven not only by real shocks, but also by financial shocks, (2) the financial sector can amplify the transmission of (real) shocks, and (3) the financial/banking shocks and the banking sectors can be sources of business cycle asymmetries and spillovers across countries in a monetary union. JEL Classification: E51, E32, E44, F45, F47
    Keywords: banks, DSGE models, econometric models, financial frictions, open-economy macroeconomics, policy analysis
    Date: 2016–06
  7. By: Fernando Fernández-Rodríguez (Department of Quantitative Methods in Economics, Universidad de Las Palmas de Gran Canaria, 35017 Las Palmas de Gran Canaria, Spain.); Marta Gómez-Puig (Department of Economic Theory, Universitat de Barcelona. 08034 Barcelona, Spain.); Simón Sosvilla-Rivero (Complutense Institute of International Studies Department of Quantitative Economics, Universidad Complutense de Madrid.)
    Abstract: This paper measures the connectedness in EMU sovereign market volatility between April 1999 and January 2014, in order to monitor stress transmission and to identify episodes of intensive spillovers from one country to the others. To this end, we first perform a static and dynamic analysis to measure the total volatility connectedness in the entire period (the system-wide approach) using a framework recently proposed by Diebold and Yılmaz (2014). Second, we make use of a dynamic analysis to evaluate the net directional connectedness for each country and apply panel model techniques to investigate its determinants. Finally, to gain further insights, we examine the time-varying behaviour of net pair-wise directional connectedness at different stages of the recent sovereign debt crisis.
    Keywords: Sovereign debt crisis; Euro area; Market linkages; Vector autoregression; Variance decomposition.
    Date: 2015
  8. By: Fernando Fernández-Rodríguez (Department of Quantitative Methods in Economics, Universidad de Las Palmas de Gran Canaria.); Marta Gómez-Puig (Department of Economic Theory, Universitat de Barcelona.); Simón Sosvilla-Rivero (Complutense Institute of International Studies, Universidad Complutense de Madrid.)
    Abstract: We analyse volatility spillovers in EMU sovereign bond markets. First, we examine the unconditional patterns during the full sample (April 1999-January 2014) using a measure recently proposed by Diebold and Yılmaz (2012). Second, we make use of a dynamic analysis to evaluate net directional volatility spillovers for each of the eleven countries under study, and to determine whether core and peripheral markets present differences. Finally, we apply a panel analysis to empirically investigate the determinants of net directional spillovers of this kind.
    Keywords: Sovereign debt crisis; Euro area; Market Linkages; Vector Autoregression; Variance Decomposition.
    JEL: C53 E44 F36 G15
    Date: 2015
  9. By: Martin Geiger; Richard Hule
    Abstract: We study the potential role of correlated refinancing abilities among different countries for the disruption of government bond markets in a currency union. Following Morris and Shin (2004) we use a global games framework and model the simultaneous investment decision into two assets, which are subject to correlated fundamental states, as a coordination problem with correlated imperfect information. Based on this model we evaluate the role of information about one country for the coordination of creditors of another country. We find, however, that the contagious effects on the price of debt precipitated through correlation are modest. Hence, assuming that investors behave as modeled in the global game, we conclude that correlated fundamentals that precipitate informational spillovers appear to be unlikely to play a major role for e.g. the disruption of some Eurozone government bond markets in the aftermath of the recent financial and economic crisis.
    Keywords: Government bond refinancing, global games, creditor coordination, currency union
    JEL: D82 G12
    Date: 2016–06
  10. By: Keiber, Karl Ludwig; Samyschew, Helene
    Abstract: This paper studies whether sentiment is rewarded with a significant risk premium on the European stock markets. We examine several sentiment proxies and identify the Economic Sentiment Indicator (ESI) from the EU Commission as the most relevant sentiment proxy for our sample. The analysis is performed for the contemporaneous excess returns of eleven euro area (EA-11) stock markets in the period from February 1999 to September 2015. We apply a conditional multiplebeta pricing model in order to track the variation of the sentiment risk premium over time. The results demonstrate a positive significant relationship between sentiment and contemporaneous excess returns which is consistent to the previous studies. The calculated sentiment risk premium is significant as well but of a negative sign implying that an investment in EA-11 countries over the examined time period would have been unattractive to the investors on average.
    Keywords: international asset pricing,European risk premia,sentiment risk,conditional asset-pricing model
    JEL: G12 G15
    Date: 2016
  11. By: Zachary Stangebye (University of Notre Dame)
    Abstract: In a finite-horizon model of sovereign debt and default, I show that long-term debt and the lack of ability to commit to future debt issuance can give rise to a multiplicity of debt and spread trajectories despite the ability to commit to contemporaneous debt issuance in terminal periods. This multiplicity bears resemblance to recent events in the Peripheral Eurozone. In a simple calibrated exercise, I find that 380 basis points (84.6%) of the spread during the crisis may be imputable to such coordination failures; if the model is extended to include bank bailouts, it can also explain 46.63 percentage points (37.8%) of the debt-to-GDP build-up. Policy analysis reveals that both austerity measures and liquidity provision by the central bank can eliminate malignant debt trajectories, but that the latter is more likely to have resolved the crisis.
    Date: 2016
  12. By: Bruno Bonizzi (SOAS, University of London); Jan Toporowski (SOAS, University of London)
    Abstract: This paper evaluates the role of emerging and developing economies as providers of finance to the European Union. In particular it explores the evolution of foreign exchange reserves accumulated in Euro, and direct investment to the European Union from emerging and developing countries. It is argued that such financial flows are unlikely to promote substantial economic development in European countries.
    Keywords: Foreign direct investment, foreign exchange reserves, European Union, Developing Countries
    JEL: F31 F23
    Date: 2016–01–01
  13. By: Janusz J. Tomidajewicz (Department of Economic and Local Government Policy Poznan University of Economics)
    Abstract: The processes of financial-system privatisation and commodification in the European countries investigated here took place mostly as a result of changes in the legal and organisational framework for conducting financial activity and as a consequence of individual privatisation decisions taken mainly for macroeconomic reasons. This suggests the predominance of ideological and macroeconomic reasons for the process in Europe. The phenomenon was most clearly visible in CEE countries, although it could also be seen in the privatisation processes taking place in countries of Western Europe. As a result, differences in the subjective and objective scope of financial-sector privatisation in particular European countries should be attributed much more to the influence of ideological reasons – an influence stemming largely from the impact of pressure groups interested in privatisation – than to pressure from the economic determinants of financial activity manifesting themselves in microeconomic reasons for privatisation
    Keywords: privatisation, commodification, financial sector, liberalisation
    JEL: L33 G18 E02
    Date: 2015–03–01
  14. By: Hayette Gatfaoui (IESEG School of Management (LEM) et Centre d'Economie de la Sorbonne); Isabelle Nagot (Centre d'Economie de la Sorbonne); Philippe de Peretti (Centre d'Economie de la Sorbonne)
    Abstract: In this article, we consider financial markets as complex dynamical systems, and check whether the critical slowing down indicators can be used as early warning signals to detect a phase transition. Using various rolling windows, we analyze the evolution of three indicators: i) First-order autocorrelation, ii) Variance, and iii) Skewness. Using daily data for ten European stock exchanges plus the United States, and focusing on the Global Financial Crisis, our results are mitigated and depend both on the series used and the indicator. Using the main (log) indices, critical slowing down indicators seem weak to predict to Global Financial Crisis. Using cumulative returns, for almost all countries an increase in variance and skewness does preceed the crisis. However, first-order autocorrelations of both log-indices and cumulative returns do not provide any useful information about the Global Financial Crisis. Thus, only some of the reported critical slowing down indicators may have informational content, and could be used as early warnings
    Keywords: Global Financial Crisis; Critical Slowing Down; Complex Dynamical System; Phase Transition
    JEL: G17 C18 C52
    Date: 2016–06
  15. By: López-Pérez, Víctor
    Abstract: This paper explores how changes in macroeconomic uncertainty have affected the decision to reply to the European Central Bank's Survey of Professional Forecasters (ECB's SPF). The results suggest that higher (lower) aggregate uncertainty increases (reduces) non-response to the survey. This effect is statistically and economically significant. Therefore, the assumption that individual ECB's SPF data are missing at random may not be appropriate. Moreover, the forecasters that perceive more individual uncertainty seem to have a lower likelihood of replying to the survey. Consequently, measures of uncertainty computed from individual ECB's SPF data could be biased downwards.
    Keywords: Non-response,uncertainty,Survey of Professional Forecasters,European Central Bank
    JEL: D81 D84 E66
    Date: 2016
  16. By: Homar, Timotej; Kick, Heinrich; Salleo, Carmelo
    Abstract: We analyse the SRISK measure with respect to its usage as a benchmark for the ECB/EBA 2014 stress test. By regressing the ECB/EBA stress test impact and the SRISK stress impact on a set of factors that are commonly associated with bank credit losses and bank vulnerability, we find that the ECB/EBA stress impact is consistent with findings in the literature on credit losses. In contrast, the SRISK measure bears much less relation to these factors; it is largely driven by the banks’ leverage ratio. These differences are deeply rooted in the construction of the respective measures. With its focus on losses to bank equity, the SRISK measure appears poorly matched as a benchmark for the supervisory stress test in Europe, which is centred on losses to banks’ total assets. JEL Classification: C21, G01, G21
    Keywords: Asset Quality Review, SRISK, stress test evaluation
    Date: 2016–06
  17. By: Piotr Krajewski (Institute of Economics, Faculty of Economics and Sociology, University of Lodz, Poland)
    Abstract: We analyse the effects of fiscal policy in non-EMU Central and Eastern European counties. The analysis is based on new Keynesian model, which takes into account both optimizing Ricardian households and non-Ricardian households with liquidity constraints. Results of the study indicate that the share of non-Ricardians has significant impact on fiscal multipliers. The government spending multiplier reaches 3 in the country with highest share of non- Ricardian households, whereas in the country with lowest share of non-Ricardians is lower than one. Also effects of government spending shocks on consumption are very sensitive to the share of households with liquidity constraints.
    Keywords: fiscal policy, government spending, new Keynesian model, heterogeneity of households, non-Ricardian households.
    JEL: E32
    Date: 2016–05
  18. By: Nicolini, Juan Pablo (Federal Reserve Bank of Minneapolis)
    Abstract: In this paper, we discuss conditions under which adverse expectations can trigger abrupt and large changes in the interest rate at which a sovereign country can borrow in international financial markets. We argue that such changes are caused by self-fulfilling expectations outcomes, in which interest rates are high because the perceptions of future defaults are high, but those perceptions are high precisely because the interest rates are high. {{p}} A model based on these elements successfully simulates the near-default experience of Greece, Italy, Spain and Portugal, among other countries. We show that self-fulfilling traps can occur when two conditions are met: First, the existing level of government debt must be relatively high; second, the probability that the country faces a long period of economic stagnation must be substantial. {{p}} We also show that if a sufficiently large institution is willing to lend to the country, these self-fulfilling traps can be eliminated. Our model thus suggests that the Outright Monetary Transactions (OMT) program adopted by the European Central Bank in the summer of 2012 saved southern European countries from a massive sovereign debt crisis.
    Date: 2016–06–28
  19. By: Orphanides, Athanasios
    Abstract: Under ordinary circumstances, the fiscal implications of central bank policies tend to be seen as relatively minor and escape close scrutiny. The global financial crisis of 2008, however, demanded an extraordinary response by central banks which brought to light the immense power of central bank balance sheet policies as well as their major fiscal implications. Once the zero lower bound on interest rates is reached, expanding a central bank's balance sheet becomes the central instrument for providing additional monetary policy accommodation. However, with interest rates near zero, the line separating fiscal and monetary policy is blurred. Furthermore, discretionary decisions associated with asset purchases and liquidity provision, as well as with lender-of-last-resort operations benefiting private entities, can have major distributional effects that are ordinarily associated with fiscal policy. In the euro area, discretionary central bank decisions can have immense distributional effects across member states. However, decisions of this nature are incompatible with the role of unelected officials in democratic societies. Drawing on the response to the crisis by the Federal Reserve and the ECB, this paper explores the tensions arising from central bank balance sheet policies and addresses pertinent questions about the governance and accountability of independent central banks in a democratic society.
    Keywords: central bank accountability; central bank governance; central bank independence; lender of last resort; loss sharing; monetary financing; Quantitative easing; rules vs discretion.
    JEL: E52 E58 E61 G01 H12
    Date: 2016–07
  20. By: Miguel Faria-e-Castro (New York University); Luis Fonseca (London Business School); Matteo Crosignani (NYU Stern)
    Abstract: We analyze some of the potentially unintended consequences of the largest liquidity injection ever conducted by a central bank: the European Central Bank’s three-year Long-Term Refinancing Operations conducted in December 2011 and February 2012. Using an unique dataset on monthly security- and bank-level holdings of government bonds for Portugal, we analyze the impact of this unconventional monetary policy operation on the demand for government debt. We find that: (i) Portuguese banks significantly increased their holdings of domestic government bonds after the announcement of this policy; (ii) This increase in holdings was tilted towards shorter maturities, with banks rebalancing their sovereign debt portfolios towards shorter term bonds. We employ a theoretical framework to argue that domestic banks engaged in a “collateral trade†, which involved the purchase of high yield bonds with maturities shorter than the central bank borrowing in order to mitigate funding liquidity risk. Our model delivers general equilibrium implications that are consistent with the data: the yield curve for the Portuguese sovereign steepens after the announcement, and the timing and characteristics of government bond auctions are consistent with a strategic response by the debt management agency.
    Date: 2016

This nep-eec issue is ©2016 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.