nep-eec New Economics Papers
on European Economics
Issue of 2018‒04‒16
eighteen papers chosen by
Giuseppe Marotta
Università degli Studi di Modena e Reggio Emilia

  1. Revisiting the Economic Case for Fiscal Union in the Euro Area By Helge Berger; Giovanni Dell'Ariccia; Maurice Obstfeld
  2. Credit Risk Determinants in the Vulnerable Economies of Europe: Evidence from the Italian Banking System By Esida Gila-Gourgoura; Eftychia Nikolaidou
  3. Euro area real-time density forecasting with financial or labor market frictions By McAdam, Peter; Warne, Anders
  4. On the Persistence of UK Inflation: A Long-Range Dependence Approach By Guglielmo Maria Caporale; Luis A. Gil-Alana; Tommaso Trani
  5. Parameter heterogeneity, persistence and cross-sectional dependence: new insights on fiscal policy reaction functions for the Euro area By R. Golinelli; I. Mammi; A. Musolesi
  6. Pricing sovereign contingent convertible debt By Andrea Consiglio; Michele Tumminello; Stavros A. Zenios
  7. Sovereign risk and asset market dynamics in the euro area By Erica Perego
  8. Investment as a transmission mechanism from weak demand to weak supply and post-crisis productivity slowdown By Patrice Ollivaud; Yvan Guillemette; David Turner
  9. Competitiveness and Wage Bargaining Reform in Italy By Alvar Kangur
  10. The More the Merrier? The Reaction of Euro Area Stock Markets to New Members By Zana Grigaliuniene; Dmitrij Celov; Christopher A. Hartwell
  11. Market discipline and liquidity key issues in the EMU reform By Vihriälä, Vesa
  12. Italy: Quantifying the Benefits of a Comprehensive Reform Package By Michal Andrle; Alvar Kangur; Mehdi Raissi
  13. Disinflation and improved anchoring of long-term inflation expectations - The Icelandic experience By Thórarinn G. Pétursson
  14. Non-Observed Economy vs. the Shadow Economy in the EU: The Accuracy of Measurements Methods and Estimates revisited By Philippe Adair
  15. The IT Revolution and Southern Europe’s Two Lost Decades By Fabiano Schivardi; Tom Schmitz
  16. Aggregate multi-factor productivity: measurement issues in OECD countries By Balázs Egert
  17. Are UK industries resilient in dealing with uncertainty? The case of Brexit By Jamal Bouoiyour; Refk Selmi
  18. The international transmission of monetary policy By Buch, Claudia M.; Bussiere, Matthieu; Goldberg, Linda S.; Hills, Robert

  1. By: Helge Berger; Giovanni Dell'Ariccia; Maurice Obstfeld
    Abstract: The paper makes an analytical contribution to the revived discussion about the euro area’s institutional setup. After significant progress during the euro crisis, the drive to complete Europe’s Economic and Monetary Union (EMU) had stalled, and the way forward will benefit from an in-depth look at the conceptual issues raised by the evolution and architecture of Europe, and the tradeoffs involved. A thorough look at the underlying economic issues suggests that in the long run, EMU will benefit from progressing along three mutually supporting tracks: introduce more fiscal risk sharing, helping to make the sovereign “no bailout” rule credible; complementary financial sector reforms to delink sovereigns and banks; and more effective rules to discourage moral hazard. This evolution would ensure that financial markets provide incentives for fiscal discipline. Introducing more fiscal union comes with myriad legal, technical, operational, and political problems, raising questions well beyond the remit of economics. But without decisive progress to foster fiscal risk sharing, EMU will continue to face existential risks.
    Keywords: Sweden;Switzerland;United Kingdom;Monetary unions;Spain;Italy;Fiscal policy;France;Germany;Greece;Austria;Belgium;Czech Republic;Denmark;Economic integration;Europe;European Economic and Monetary Union;European Monetary Union;Euro area; currency union; fiscal union; fiscal risk sharing; governance; bailout; fiscal rules, General, Financial Aspects of Economic Integration, International Policy Coordination and Transmission, Intergovernmental Relations, Governmental Loans and Credits
    Date: 2018–02–20
  2. By: Esida Gila-Gourgoura (School of Economics, University of Cape Town); Eftychia Nikolaidou (School of Economics, University of Cape Town)
    Abstract: This study uses the Autoregressive Distributed Lag (ARDL) approach to cointegration to identify the factors affecting credit risk in the Italian banking system over the period 1997Q4–2017Q1. The ratio of new bad loans to the outstanding amount of performing loans in the previous period is the selected proxy of credit risk whereas a wide range of explanatory variables are included in the study, taking stock from the related literature and the specific features of Italy. Compared to the previous studies, a wider timeframe is investigated, which captures the booming period, the global financial crisis and the ongoing Eurozone sovereign debt crisis. The findings suggest that macroeconomic cyclical, bank-specific, and financial market variables affect the flow of new bad loans in the Italian banking system. The high significance of the sovereign debt crisis risk proxy signals the important link between banking and sovereign debt crisis both in the short and in the long term and therefore rings a bell to fiscal and monetary authorities in Italy and the Euro area.
    Date: 2018
  3. By: McAdam, Peter; Warne, Anders
    Abstract: We compare real-time density forecasts for the euro area using three DSGE models. The benchmark is the Smets-Wouters model and its forecasts of real GDP growth and inflation are compared with those from two extensions. The first adds financial frictions and expands the observables to include a measure of the external finance premium. The second allows for the extensive labor-market margin and adds the unemployment rate to the observables. The main question we address is if these extensions improve the density forecasts of real GDP and inflation and their joint forecasts up to an eight-quarter horizon. We find that adding financial frictions leads to a deterioration in the forecasts, with the exception of longer-term inflation forecasts and the period around the Great Recession. The labor market extension improves the medium to longer-term real GDP growth and shorter to medium-term inflation forecasts weakly compared with the benchmark model. JEL Classification: C11, C32, C52, C53, E37
    Keywords: Bayesian inference, DSGE models, forecast comparison, inflation, output, predictive likelihood
    Date: 2018–04
  4. By: Guglielmo Maria Caporale; Luis A. Gil-Alana; Tommaso Trani
    Abstract: This paper examines the degree of persistence in UK inflation by applying long-memory methods to historical data that span the period from 1660 to 2016. Specifically, we use both parametric and non-parametric fractional integration techniques, that are more general than those based on the classical I(0) vs. I(1) dichotomy. Further, we carry out break tests to detect any shifts in the degree of persistence, and also run rolling-window and recursive regressions to investigate its evolution over time. On the whole, the evidence suggests that the degree of persistence of UK inflation has been relatively stable following the Bretton Woods period, despite the adoption of different monetary regimes. The estimation of an unobserved-components stochastic volatility model sheds further light on the issues of interest by showing that post-Bretton Woods changes in UK inflation are attributable to a fall in the volatility of permanent shocks.
    Keywords: UK inflation, persistence, fractional integration
    JEL: C14 C22 E31
    Date: 2018
  5. By: R. Golinelli; I. Mammi; A. Musolesi
    Abstract: A number of novelties have emerged in the study of the discretionary fiscal policy within the Euro area during the last decade. Among the others, the availability of up-to-date information on fiscal indicators for the years following the Great Recession, the introduction of cutting-edge econometric methods, and a renewed interest about the sustainability of fiscal policy and public debt. The aim of this paper is to address the challenges posed by the estimation of the discretionary fiscal reaction function for the Euro area. We exploit recently introduced testing and estimation strategies for heterogeneous dynamic panels with cross-sectional dependence and propose a new parsimonious approach. Using real-time data over the period 1996-2016, we investigate whether the fiscal policy reaction function is still a benchmark after the Great Recession. We find evidence of strong cross-sectional dependence in the panel, and clear support to a valid cointegration relationship among the main determinants of the function. Newly added covariates, such interest rate spreads, come out to play a relevant role in explaining discretionary actions.
    JEL: E62 E61 H60 D80 C33
    Date: 2018–04
  6. By: Andrea Consiglio; Michele Tumminello; Stavros A. Zenios
    Abstract: We develop a pricing model for Sovereign Contingent Convertible bonds (S-CoCo) with payment standstills triggered by a sovereign's Credit Default Swap (CDS) spread. We model CDS spread regime switching, which is prevalent during crises, as a hidden Markov process, coupled with a mean-reverting stochastic process of spread levels under fixed regimes, in order to obtain S-CoCo prices through simulation. The paper uses the pricing model in a Longstaff-Schwartz American option pricing framework to compute future state contingent S-CoCo prices for risk management. Dual trigger pricing is also discussed using the idiosyncratic CDS spread for the sovereign debt together with a broad market index. Numerical results are reported using S-CoCo designs for Greece, Italy and Germany with both the pricing and contingent pricing models.
    Date: 2018–04
  7. By: Erica Perego (University of Evry-Val d’Essonne)
    Abstract: This paper studies the behaviour of euro area asset market comovements during the period 2010- 2014, through the lens of a DSGE model. The economy is a two-country world consisting of a core and a periphery and featuring an international banking sector, home bias in bond holdings, and default. The periphery is buffeted by a sovereign risk shock, whose process is estimated from the data. The model successfully accounts for the divergence in core-periphery correlations between stock and bond returns. Simulation results indicate that the sovereign risk shock explains 50% of the increase in sovereign and loan-deposit spreads and 7% of the decrease in global output during the sovereign debt crisis.
    Keywords: Currency union, international financial markets, sovereign risk, general equilibrium
    JEL: F41 F44 G15
    Date: 2018
  8. By: Patrice Ollivaud; Yvan Guillemette; David Turner
    Abstract: Current weak labour productivity growth in many OECD countries reflects historically weak contributions from both total factor productivity (TFP) growth and capital deepening. The slowdown in trend productivity growth in the pre-crisis period is mostly explained by a long-established slowdown in TFP growth, but since the crisis the further deceleration is mainly due to weak capital deepening, a development apparent in practically every OECD country. Much of the weakness in the growth of the capital stock since the financial crisis can be explained by an accelerator response of investment to continued demand weakness, leading in turn to a deterioration of potential output via a hysteresis-like effect. For the most severely affected economies, the financial crisis is estimated to have reduced potential output by more than 2% via this transmission mechanism. In many OECD countries, declining government investment as a share of GDP has further exacerbated post-crisis weakness in capital stock growth, both directly and probably indirectly via adverse spillover effects on business investment. Finally, over a period when the use of conventional macro policy instruments was constrained, the slower pace of structural reform represents a missed opportunity, not least because more competition-friendly product market regulation could have boosted both investment and potential growth.
    Keywords: accelerator effect, capacity, capital stock, financial crisis, global financial crisis, hysteresis, investment, potential output
    JEL: E22 E27 E32 E65 E66
    Date: 2018–04–16
  9. By: Alvar Kangur
    Abstract: The growth of Italian exports has lagged that of euro area peers. Against the backdrop of unit labor costs that have risen faster than those in euro area peers, this paper examines whether there is a competitiveness challenge in Italy and evaluates the framework of wage bargaining. Wages are set at the sectoral level and extended nationally. However, they do not respond well to firm-specific productivity, regional disparities, or skill mismatches. Nominally rigid wages have also implied adjustment through lower profits and employment. Wage developments explain about 45 percent of the manufacturing unit labor cost gap with Germany. In a search-and-match DSGE model of the Italian labor market, this paper finds substantial gains from moving from sectoral- to firm-level wage setting of at least 3.5 percentage points lower unemployment (or higher employment) rate and a notable improvement in Italy’s competitiveness over the medium term.
    Date: 2018–03–16
  10. By: Zana Grigaliuniene (QAHE NU London campus); Dmitrij Celov (Vilnius University, Faculty of Economics and Business Administration, Quantitative Methods and Modelling Department); Christopher A. Hartwell (Bournemouth University, Department of Accounting, Finance & Economics; Kozminski University, Department of International Management)
    Abstract: The adoption of the euro is a crucial turning point for the economy of any EU member and the culmination of a long process of exchange rate management and macroeconomic convergence. But how does the prospect of euro area enlargement play out in the countries that have already adopted the euro? Are new members seen as a way to expand the club of like-minded countries, or are they perceived as a threat to stability, either because there exists a moral hazard risk from the side of old members to adopt riskier behavior on behalf of new members or vice versa? This paper looks at the effects of the news of the euro’s adoption event in new members on the stock returns of nineteen euro area countries, employing both an event study methodology and APARCH modeling to capture and test the form of responses of European financial market volatility. Our results show that markets were indeed pleased when new members joined the euro area, with negative responses due solely to local conditions rather than euro area-wide travails. In our most interesting finding, the expansion of the euro actually helped to dampen local market volatility in the post-crisis period in the founding member states, while euro adoption quelled volatility both pre- and post-crisis for non-founding members.
    Keywords: euro, currency union, asymmetric effects, event study, APARCH, volatility
    JEL: G15 F36 F33
    Date: 2018–04
  11. By: Vihriälä, Vesa
    Abstract: The EMU institutions need to be reformed. There is, however, a deep disagreement about the right way to proceed. Some see increased risk sharing and centralisation of decision making as being essential, while others emphasise risk reduction and market discipline. A recent paper by a group of French and German economists combines these elements in an interesting way. The paper is the most promising blueprint for an economically sensible and politically feasible EMU reform to date. Still, it falls short of making market discipline on sovereign nations a credible approach, as it does not deal adequately with the problem of avoiding contagion when resorting to debt restructuring. A way to address this difficult problem might be to give the crisis management body, the ESM or a future EMF, access to central bank financing with appropriate constraints. This would allow prompt and effective action to be taken in order to protect solvent member states against market pressures when debt needs to be restructured for the insolvent ones. On the other hand, one should ditch the idea of a fiscal capacity for cyclical stabilisation across member states, an idea also presented in the paper. It would be an inefficient means of reducing risk of financial instability, which is the fundamental problem of the EMU. Prudent fiscal policy during good times allows member states to smooth aggregate demand sufficiently well in times of crisis.
    Keywords: EMU, ESM, ECB, market discipline, debt restructuring, liquidity
    Date: 2018–04–12
  12. By: Michal Andrle; Alvar Kangur; Mehdi Raissi
    Abstract: This paper seeks to quantify the net benefits of a comprehensive reform package aimed at addressing Italy’s inter-related challenges. Specifically, it simulates the growth and competitiveness effects of a package of fiscal, financial, wage bargaining, and other structural reforms. Credible implementation of such a package yields substantial mediumterm dividends at negligible near-term growth costs. Real GDP growth is estimated to be substantially higher over the medium term, while the real effective exchange rate depreciates notably.
    Date: 2018–03–16
  13. By: Thórarinn G. Pétursson
    Abstract: After rising sharply following the Global Financial Crisis, inflation in Iceland has been low and stable in recent years despite a strong cyclical recovery. This not only reflects good luck – stemming from low global inflation, declining commodity prices, and a currency appreciation – but also a significant improvement in monetary policy credibility as reflected in a large decline in long-term inflation expectations. To quantify these effects, a forward-looking, open-economy Phillips curve is estimated for the inflation-targeting period since 2001. The empirical results suggest a structural shift in the average relation between inflation and its key drivers occurring around 2012. It is argued that this reflects the convergence of long-term inflation expectations of households and firms towards the downward trending inflation expectations in financial markets. Long-term inflation expectations of households and firms are not observed, but using a Markov switching model and a time-varying parameter model suggests that this unobserved component of long-term inflation expectations has declined from an average of about 2 percentage points in 2003-2011 to zero in late 2016. Together with the large decline in imported inflation, the improved anchoring of long-term inflation expectations goes a long way towards explaining the large disinflation of the last five years and the low recent inflation despite the strong pickup in economic activity. It also seems that an important part of the persistent over-prediction of inflation in Iceland by most forecasters in recent years can be explained by the failure to take the gradual improvement in monetary policy credibility since 2012 into account. Finally, this combination of imported deflation and a firmer anchoring of inflation expectations can explain why the post-2012 disinflation episode did not coincide with any loss of output.
    Date: 2018–03
  14. By: Philippe Adair (ERUDITE - Equipe de Recherche sur l’Utilisation des Données Individuelles en lien avec la Théorie Economique - UPEM - Université Paris-Est Marne-la-Vallée - UPEC UP12 - Université Paris-Est Créteil Val-de-Marne - Paris 12)
    Abstract: The Non-Observed Economy (NOE) vs. the shadow economy remains a controversial issue. Illegal, underground and informal activities encapsulated within the NOE/shadow economy display large discrepancies throughout the European Union. First, a tractable taxonomy of the aforementioned market activities is designed according to both definition and scope, whereupon a wide spectrum of estimation methods applies. Second, direct measurements provided by tax audits, household informal expenditure and labour market surveys provide piecemeal information regarding such unobserved activities; a cross-section survey issued from a unique questionnaire applied to all European countries in 2007 and again in 2013 deserves special attention. Third, indirect macroeconomic measurements are drawn from discrepancies on the market for goods and services on the money market and on the labour market, whereas the DYMIMIC (dynamic multiple indicators-multiple causes) method carves the trends of the shadow economy (hereafter SE). Fourth, the estimates of the EU shadow economy drawn from the DYMIMIC model are compared with the assessment of the NOE according to national accounts adjustments; the relevance of major determinants of the NOE/shadow economy-tax burden as well as the characteristics of the informal workforce, is discussed.
    Keywords: Shadow Economy ,Estimates,European Union,Measurement Methods,National Accounts
    Date: 2017–11–25
  15. By: Fabiano Schivardi (Università LUISS "Guido Carli"); Tom Schmitz (Università Bocconi)
    Abstract: Since the middle of the 1990s, productivity growth in Southern Europe has been substantially lower than in other developed countries. In this paper, we argue that this divergence was partly caused by inefficient management practices, which limited Southern Europe’s gains from the IT Revolution. To quantify this effect, we build a multi-country general equilibrium model with heterogeneous firms and workers. In our model, the IT Revolution generates divergence for three reasons. First, inefficient management limits Southern firms’ productivity gains from IT adoption. Second, IT increases the aggregate importance of management, making its inef- ficiencies more salient. Third, IT-driven wage increases in other countries stimulate Southern high-skill emigration. We calibrate our model using firm-level evidence, and show that it can account for 28% of Italy’s, 39% of Spain’s and 67% of Portugal’s productivity divergence with respect to Germany between 1995 to 2008.
    Keywords: L23, O33
    Date: 2018
  16. By: Balázs Egert
    Abstract: This paper analyses for 34 OECD countries the extent to which the calculation of aggregate multi-factor productivity (MFP) is sensitive to alternative parameterisations. The starting point is the definition of MFP used in previous work in the OECD’s Economics Department (e.g. Johansson et al. 2013). They include alternative MFP measures, with human capital included or excluded, with different measures of Purchasing Power Parity (PPP) exchange rates, using time-varying capital depreciation rates and different measures of capital stock and labour input (headcount against hours worked). The main result of the paper is that whether or not human capital is included in MFP makes a significant difference for the level and dynamics of MFP. At the same time, MFP measures are less sensitive to other parameters of the calculation.
    Keywords: multi-factor productivity, measurement, human capital, OECD
    JEL: O4
    Date: 2018
  17. By: Jamal Bouoiyour (CATT - Centre d'Analyse Théorique et de Traitement des données économiques - UPPA - Université de Pau et des Pays de l'Adour); Refk Selmi (CATT - Centre d'Analyse Théorique et de Traitement des données économiques - UPPA - Université de Pau et des Pays de l'Adour)
    Abstract: Given the European Union (EU)'s central role in regulating various sectors, the decision to leave poses profound questions for UK industries in upheaval. This paper adopts an event-study methodology to examine, at sectoral level, the dynamics of stock prices surrounding the announcement of the UK's EU membership referendum on 24 June 2016. We find that the adjustment of stock prices is inconsistent with the Uncertain Information Hypothesis assuming that policy changes are typically associated to a decrease of stock prices, but once the uncertainty-induced event is reduced, stock prices would increase again. Analyzing seven sectors of British stock index, we show that the Brexit had a significant impact on the valuation of UK companies. While all industries face increasing uncertainty, the referendum outcome had varying sectoral effects. Specifically, the responses of banks and financial services, defense and airlines, real estate and technology to the Brexit event were even more severe than the reactions of oil and gas, pharmaceuticals and consumer goods. The lack of opportunity to benefit from the European passporting rules to establish businesses, to access to EU's Research and Development funds and to hire the skilled workers have been offered to explain the adverse effects of Brexit on UK industries.
    Keywords: Brexit,uncertainty,stock market,sectoral-level analysis,UK,event-study methodology
    Date: 2018
  18. By: Buch, Claudia M. (Deutsche Bundesbank); Bussiere, Matthieu (Banque de France); Goldberg, Linda S. (Federal Reserve Bank of New York); Hills, Robert (Bank of England)
    Abstract: This paper presents the novel results from an internationally coordinated project by the International Banking Research Network (IBRN) on the cross-border transmission of conventional and unconventional monetary policy through banks. Teams from seventeen countries use confidential micro-banking data for the years 2000 through 2015 to explore the international transmission of monetary policies of the United States, the euro area, Japan, and the United Kingdom. Two other studies use international data with different degrees of granularity. International spillovers into lending to the private sector do occur, especially for U.S. policies, and bank-specific heterogeneity influences the magnitudes of transmission. The effects are supportive of the international bank lending channel and the portfolio channel of monetary policy transmission. They also show that the frictions that banks face matter; in particular, foreign currency funding and hedging considerations can be a key source of heterogeneity. The forms of bank balance sheet heterogeneity that differentiate spillovers across banks are not uniform across countries. International spillovers into lending can be large for some banks, even while the average international spillovers of policies into nonbank lending generally are not large.
    Keywords: monetary policy; international spillovers; cross-border transmission; global bank; global financial cycle
    JEL: E52 F3 F4 G15 G21
    Date: 2018–03–01

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