nep-eec New Economics Papers
on European Economics
Issue of 2018‒04‒23
seventeen papers chosen by
Giuseppe Marotta
Università degli Studi di Modena e Reggio Emilia

  1. “Whatever it takes” to resolve the European sovereign debt crisis? Bond pricing regime switches and monetary policy effects By Afonso, António; Arghyrou, Michael G; Gadea, María Dolores; Kontonikas, Alexandros
  2. The effects of unconventional monetary policy in the euro area By Adam Elbourne; Kan Ji; Sem Duijndam
  3. Monetary policy, de-anchoring of inflation expectations, and the 'new normal' By Lucio Gobbi; Ronny Mazzocchi; Roberto Tamborini
  4. Completing the Banking Union with a European Deposit Insurance Scheme: who is afraid of cross-subsidisation? By Carmassi, Jacopo; Dobkowitz, Sonja; Evrard, Johanne; Parisi, Laura; Silva, André; Wedow, Michael
  5. Revisiting Public Support for the Euro, 1999-2017: Accounting for the Crisis and the Recovery By Roth, Felix; Baake, Edgar; Jonung, Lars; Nowak-Lehmann, Felicitas
  6. Effects of Unconventional Monetary Policy on European Corporate Credit By Machiel van Dijk; Andrei Dubovik
  7. Public sector efficiency in Europe: Long-run trends, recent developments and determinants By Christl, Michael; Köppl-Turyna, Monika; Kucsera, Dénes
  8. A stochastic estimated version of the Italian dynamic General Equilibrium Model (IGEM) By Nicola Acocella; Giorgio Alleva; Elton Beqiraj; Giovanni Di Bartolomeo; Fabio Di Dio; Marco Di Pietro; Francesco Felici; Brunero Liseo
  9. The Response of European Energy Prices to ECB Monetary Policy By Hipòlit Torró
  10. Can Risk Models Extract Inflation Expectations from Financial Market Data? Evidence from the Inflation Protected Securities of Six Countries By Daniel L. Tortorice; Arben Kita
  11. Application of the integrated accounts framework for empirical investigation of the economic and financial cycle in Lithuania By Tomas Ramanauskas; Skirmante Matkenaite; Virgilijus Rutkauskas
  12. Sovereign risk and bank risk-taking By Ari, Anil
  13. Macroeconomic Determinants of the Labour Share of Income: Evidence from OECD Economies By Trofimov, Ivan D.; Md. Aris, Nazaria; Bin Rosli, Muhammad K. F.
  14. Detecting Financial Collapse and Ballooning Sovereign Risk By Peter C. B. Phillips
  15. Modeling fiscal sustainability in dynamic macro-panels with heterogeneous effects: Evidence from German federal states By Feld, Lars P.; Köhler, Ekkehard A.; Wolfinger, Julia
  16. How to Solve the Greek Debt Problem By Jeromin Zettelmeyer; Emilios Avgouleas; Barry Eichengreen; Miguel Poiares Maduro; Ugo Panizza; Richard Portes; Beatrice Weder di Mauro; Charles Wyplosz
  17. Finland’s Public Sector Balance Sheet; A Novel Approach to Analysis of Public Finance By Maren Brede; Christian Henn

  1. By: Afonso, António; Arghyrou, Michael G; Gadea, María Dolores; Kontonikas, Alexandros
    Abstract: This paper investigates the role of unconventional monetary policy as a source of time-variation in the relationship between sovereign bond yield spreads and their fundamental determinants. We use a two-step empirical approach. First, we apply a time-varying parameter panel modelling framework to determine shifts in the pricing regime characterising sovereign bond markets in the euro area over the period January 1999 to July 2016. Second, we estimate the impact of ECB policy interventions on the time-varying risk factor sensitivities of spreads. Our results provide evidence of a new bond-pricing regime following the announcement of the Outright Monetary Transactions (OMT) programme in August 2012. This regime is characterised by a weakened link between spreads and fundamentals, but with higher spreads relative to the pre-crisis period and residual redenomination risk. We also find that unconventional monetary policy measures affect the pricing of sovereign risk not only directly, but also indirectly through changes in banking risk. Overall, the actions of the ECB have operated as catalysts for reversing the dynamics of the European sovereign debt crisis.
    Keywords: euro area, spreads, crisis, time-varying relationship, unconventional monetary policy
    Date: 2018–04–01
  2. By: Adam Elbourne (CPB Netherlands Bureau for Economic Policy Analysis); Kan Ji (CPB Netherlands Bureau for Economic Policy Analysis); Sem Duijndam (CPB Netherlands Bureau for Economic Policy Analysis)
    Abstract: How effective are unconventional monetary policies? Through which mechanisms do they work? Central banks have been conducting monetary policy through unconventional means such as expanding their balance sheets or forward guidance because the conventional instrument of monetary policy, the short-term policy rate, has been at or close to the zero lower bound since shortly after the fall of Lehmann Brothers. These unconventional monetary policies are new and bring with them many questions, which were addressed in the CPB policy brief ‘Onderweg naar normaal monetair beleid’ [CPB policy brief 2017/07, 8 June 2017]. Understanding how and why unconventional monetary policy works is a crucial first step for answering subsequent questions, such as the likely effects of the withdrawal of unconventional monetary policy, or about how domestic policy makers can best respond. This discussion paper contains a detailed presentation of the new scientific evidence we reported in the policy brief, and adds to the relatively scarce literature in this field We estimate the effects of unconventional monetary policy shocks on output and inflation in the euro area using data from 2009 to 2016, which covers the period of all of the major unconventional monetary policies that the ECB has used. We employ a two stage estimation strategy: first, we identify unconventional monetary policy shocks in a dedicated euro area level structural vector autoregression (SVAR) model. Subsequently we use these unconventional monetary policy shocks in country level models. By estimating the effects of unconventional monetary policy shocks in the individual countries of the euro area, we aim to shed some light on the most important transmission mechanisms through which unconventional monetary policy works. We find weak evidence that expansionary unconventional monetary policy shocks increase output growth, but the effects on inflation at the aggregate euro area level are economically insignificant. At the individual country level we find a range of responses across the countries in our sample, and those differences in the magnitudes of output responses are consistent with some of the transmission channels that have been proposed for how unconventional monetary policy works. Interestingly, though, we find that healthier banking systems at the start of our sample and lower government debts are associated with larger peak output responses. This is the opposite of what the bank lending channel predicts, which is one of the most important proposed channels. We are not the only authors to have found this, for example Van Dijk and Dubovik (2018) also find no evidence of the bank lending channel when they focus on the effect of the announcement of the ECB’s Asset Purchase Programme in January 2015 on lending rates.
    JEL: C32 E52
    Date: 2018–02
  3. By: Lucio Gobbi; Ronny Mazzocchi; Roberto Tamborini
    Abstract: Persistently low inflation rates in the Euro Area raise the question whether inflation is still credibly anchored to the Euro-system’s medium term target of below, but close to 2%. The purpose of this paper is twofold. First, we investigate why agents’ expectations that over the business cycle inflation will remain in line with the target begin to falter. Our hypothesis is that agents form expectations in terms of their confidence in the "normal regime", which is updated observing the state of the economy. Second, we study how the de-anchoring of expectations interacts with monetary policy determining whether the central bank is still able to achieve its target - and hence re-anchor inflation expectations - or whether the system drifts away towards depressed states of low inflation and output. Two are our main findings. The first is that, facing unfavourable shocks, if inflation expectations "fall faster" than the policy rate, and the zero lower bound is reached without correcting the shock, the system converges to a new steady state - the “new normal†- with permanent negative gaps. The second is that a more aggressive monetary policy is ineffective both at the ZLB and above the ZLB, when the shock is large and/or when the reactivity of inflation expectations is high enough. This last finding seems to support the necessity, in those conditions, to abandon conventional monetary policy and to switch to an aggressive reflationary policy that prevents the entrenchment of deflationary expectations
    Keywords: Monetary Policy, Zero Lower Bound, New Normal, Inflation Expectations
    JEL: E50 E52 E58
    Date: 2018
  4. By: Carmassi, Jacopo; Dobkowitz, Sonja; Evrard, Johanne; Parisi, Laura; Silva, André; Wedow, Michael
    Abstract: On 24 November 2015, the European Commission published a proposal to establish a European Deposit Insurance Scheme (EDIS). The proposal provides for the creation of a Deposit Insurance Fund (DIF) with a target size of 0.8% of covered deposits in the euro area and the progressive mutualisation of its resources until a fully-fledged scheme is introduced by 2024. This paper investigates the potential impact and appropriateness of several features of EDIS in the steady state. The main findings are the following: first, a fully-funded DIF would be sufficient to cover payouts even in a severe banking crisis. Second, risk-based contributions can and should internalise specificities of banks and banking systems. This would tackle moral hazard and facilitate moving forward with risk sharing measures towards the completion of the Banking Union in parallel with risk reduction measures; this approach would also be preferable to lowering the target level of the DIF to take into account banking system specificities. Third, smaller and larger banks would not excessively contribute to EDIS relative to the amount of covered deposits in their balance sheet. Fourth, there would be no unwarranted systematic cross-subsidisation within EDIS in the sense of some banking systems systematically contributing less than they would benefit from the DIF. This result holds also when country-specific shocks are simulated. Fifth, under a mixed deposit insurance scheme composed of national deposit insurance funds bearing the first burden and a European deposit insurance fund intervening only afterwards, cross-subsidisation would increase relative to a fully-fledged EDIS. The key drivers behind these results are: i) a significant risk-reduction in the banking system and increase in banks' loss-absorbing capacity in the aftermath of the global financial crisis; ii) a super priority for covered deposits, further contributing to protect EDIS; iii) an appropriate design of risk-based contributions, benchmarked at the euro area level, following a "polluter-pays" approach. JEL Classification: G21, G28
    Keywords: cross-subsidisation, European Deposit Insurance Scheme (EDIS), risk-based contributions
    Date: 2018–04
  5. By: Roth, Felix (University of Hamburg); Baake, Edgar (University of Hamburg); Jonung, Lars (Department of Economics, Lund University); Nowak-Lehmann, Felicitas (University of Göttingen)
    Abstract: This paper explores the evolution and determinants of public support for the euro since its creation in 1999 until the end of 2017, thereby covering the pre-crisis experience of the euro, the crisis years and the recent recovery. Using uniquely large macro and micro databases and applying up-to-date econometric techniques, we revisit the growing literature on public support for the euro. First, we find that a majority of respondents support the euro in nearly all 19 euro area member states. Second, we offer fresh evidence that economic factors are the main determinants of changes in the level of support for the euro: crisis reduces support while periods of recovery bode well for public support. This result holds for both macroeconomic and microeconomic factors. Turning to a broad set of socio-economic variables, we find clear differences in support due to education and perceptions of economic status.
    Keywords: Euro; public support for the euro; ECB; EU; euro crisis; unemployment; inflation; monetary union
    JEL: C23 E24 E31 E32 E42 E58 J64 O52
    Date: 2018–04–18
  6. By: Machiel van Dijk (CPB Netherlands Bureau for Economic Policy Analysis); Andrei Dubovik (CPB Netherlands Bureau for Economic Policy Analysis)
    Abstract: In this paper we investigate whether the targeted longer-term refinancing operations (TLTRO) and the asset purchase program (APP) led to lower interest rates on new corporate credit, and whether the signalling channel and the capital relief channel played any role in the transmission of these ECB policies. We find that both APP and TLTRO contributed to lower long-term interest rates on new corporate credit and to flatter yield curves, with APP having a stronger effect. However, we find no support that either the signalling or the capital relief channel were conducive in this respect.
    JEL: E43 E58 G21
    Date: 2018–02
  7. By: Christl, Michael; Köppl-Turyna, Monika; Kucsera, Dénes
    Abstract: This paper investigates the efficiency of the public sector in a sense of public performance and expenditures. For 23 European countries and for the period between 1995 and 2015 we construct a measure of public sector performance that consist of nine distinct indices for each area of public policy, such as administration, health education, economic performance, security and infrastructure. We use several efficiency techniques (FDH, order-m) and investigate input- and output-oriented efficiency of the public sector. We find that countries with small public sectors tend to be more efficient no matter which efficiency techniques we use. Because of the relatively long time span of our data, our study contributes to the literature by analyzing the effect of the financial crisis on the efficiency of the public sector in European countries. We show that after the crisis, the public sector efficiency increased especially in countries with small public sectors, while it stayed constant or worsened in countries with big public sectors. Finally, we analyze in more depth the impact of fiscal decentralization and fiscal rules on the public sector efficiency. We conclude that while decentralization is fostering efficiency, fiscal rules do not have any effect. Moreover, fiscal rules combined with decentralization may harm efficiency, consistently with the ratchet effect.
    Keywords: public sector,efficiency,order-m,input-oriented efficiency,output-oriented efficiency,decentralization,fiscal rules
    JEL: C14 H50 H72
    Date: 2018
  8. By: Nicola Acocella; Giorgio Alleva; Elton Beqiraj; Giovanni Di Bartolomeo; Fabio Di Dio; Marco Di Pietro; Francesco Felici; Brunero Liseo
    Abstract: We estimate with Bayesian techniques the Italian dynamic General Equilibrium Model (IGEM), which has been developed at the Italian Treasury Department, Ministry of Economy and Finance, to assess the effects of alter-native policy interventions. We analyze and discuss the estimated effects of various shocks on the Italian economy. Compared to the calibrated version used for policy analysis, we find a lower wage rigidity and higher adjustment costs. The degree of prices and wages indexation to past inflation is much smaller than the indexation level assumed in the calibrated model. No substantial difference is found in the estimated monetary parameters. Estimated fiscal multipliers are slightly smaller than those obtained from the calibrated version of the model.
    Keywords: Dynamic General equilibrium model, Bayesian estimation, simulation analysis, Italy
    JEL: E27 E30 E60
    Date: 2018–04
  9. By: Hipòlit Torró (University of Valencia, Department of Financial and Actuarial Economics)
    Abstract: To our knowledge, this paper is the first to discuss the response of European energy commodity prices to unexpected monetary policy surprises from the European Central Bank. Using the Rigobon (2003) identification through heteroscedasticity method, we find a significant and positive response during the crisis period for Brent and coal. Similar results are obtained by other authors for European financial assets in this period. This result reinforces the idea that during this period, financial assets and some commodities positively responded to conventional and unconventional expansionary monetary policy measures, increasing confidence about the survival of the European monetary union. The remaining European energy commodities (electricity, EUAs, and natural gas prices) seem to be unaffected by monetary policy actions. We think these results are of interest to those economic agents and institutions involved in European energy markets and are especially important for the European Central Bank in order to predict the consequences of its monetary policy on the inflation objective.
    Keywords: Brent, Monetary Policy, European Central Bank, Energy Commodities
    JEL: C26 E58 G13 Q41
    Date: 2018–03
  10. By: Daniel L. Tortorice (Department of Economics, College of the Holy Cross); Arben Kita (Highfield Campus, University of Southampton)
    Abstract: We consider an arbitrage strategy which exactly replicates the cash of of a sovereign inflation-indexed bond using infation swaps and nominal sovereign bonds. The strategy reveals a violation of the law of one price in the G7 countries which is largest for the eurozone. Testing the strategy's exposure to deflation, volatility, liquidity, economic and policy risks suggests that the observed pricing differential is an economic tail risk premium which is more pronounced in the eurozone. We conclude that ination expec- tations implied by models that view this pricing differential as compensation for risk are likely to be accurate and useful for policy-making.
    Keywords: Inflation-Indexed Bonds, Nominal Bonds, Law of One Price, Mispricing, Limits to Arbitrage
    JEL: G12 G15 G18 H63
    Date: 2018–04
  11. By: Tomas Ramanauskas (Bank of Lithuania); Skirmante Matkenaite (Bank of Lithuania); Virgilijus Rutkauskas (Bank of Lithuania)
    Abstract: By resorting to the analytical integrated accounts framework, this paper investigates the relationship between economic and financial imbalances during the recent economic and financial cycle in Lithuania. There is clear evidence from the financial accounts data that there was a pronounced expansion of balance sheets of institutional sectors during the phase of the economic upturn, whereas the economic downturn was essentially a balance-sheet recession characterised by contracting private sector balance sheets and the reversal in credit flows and monetary dynamics. The boom-and-bust cycle was strongly associated with exuberant bank lending during the boom years, followed by a sudden reversal of lending conditions and the subsequent repatriation of debt financing by foreign banks. The Lithuanian experience also confirms that strong credit and asset price boom accompanied by economic imbalances, and debt financing of current account deficits in particular, is a potentially risky mix of economic conditions. The policy response to crisis was a market-imposed austerity but nevertheless there was a sharp rise in public debt, essentially offsetting deleveraging in the private sector. The effective replacement of growth of private sector debt with a rapid accumulation of public debt was a very important stabilising factor. Certain characteristics of bank credit (namely, its partial self-financing) imply that under some conditions economic stabilisation could have been achieved through domestic financing. However, the government had to resort to foreign financing, which was rather costly. During the crisis the monetary dynamics was driven by government borrowing from abroad, stepped up capital transfers from abroad and positive current account adjustments, all of which allowed foreign parent banks to withdraw debt financing and replace it with domestic deposit financing.
    Date: 2018–04–06
  12. By: Ari, Anil
    Abstract: I propose a dynamic general equilibrium model in which strategic interactions between banks and depositors may lead to endogenous bank fragility and slow recovery from crises. When banks’investment decisions are not contractible, depositors form expectations about bank risk-taking and demand a return on deposits according to their risk. This creates strategic complementarities and possibly multiple equilibria: in response to an increase in funding costs, banks may optimally choose to pursue risky portfolios that undermine their solvency prospects. In a bad equilibrium, high funding costs hinder the accumulation of bank net worth, leading to a persistent drop in investment and output. I bring the model to bear on the European sovereign debt crisis, in the course of which under-capitalized banks in default-risky countries experienced an increase in funding costs and raised their holdings of domestic government debt. The model is quanti…ed using Portuguese data and accounts for macroeconomic dynamics in Portugal in 20102016. Policy interventions face a trade-o¤ between alleviating banks’funding conditions and strengthening risk-taking incentives. Liquidity provision to banks may eliminate the good equilibrium when not targeted. Targeted interventions have the capacity to eliminate adverse equilibria. JEL Classification: E44, F30, F34, G01, G21, G28, H63
    Keywords: banking crises, financial constraints, risk-taking, sovereign debt crises
    Date: 2018–04
  13. By: Trofimov, Ivan D.; Md. Aris, Nazaria; Bin Rosli, Muhammad K. F.
    Abstract: The study investigates the relationships between the labour share of income and several macroeconomic variables – the GDP growth, inflation, unemployment, as well as GDP gap and capacity utilization – in industrialised economies between 1960 and the 2010s. Three complementary hypotheses that relate macroeconomic determinants to the labour share dynamics are considered: 'overhead labour' hypothesis, 'realization theory/wage lag' hypothesis and the 'rising strength of labour' hypothesis. The study employs a sequential procedure: testing for the stationarity properties of the variables, using bounds test to identify the presence of cointegrating relationships, and estimating long-run relationships using ARDL or OLS methods. The results show that all three hypotheses are supported only in a limited number of economies, whilst in the majority of cases only certain relationships are prominent. On the whole, the GDP growth rate, the unemployment rate, and to a smaller extent capacity are found to be the principal determinants of the labour share, while change in the level of prices is of subsidiary importance.
    Keywords: Labour share; time series; macroeconomic determinants
    JEL: C22 E25 J30
    Date: 2018–03–15
  14. By: Peter C. B. Phillips (Cowles Foundation, Yale University)
    Abstract: This paper proposes a new model for capturing discontinuities in the underlying financial environment that can lead to abrupt falls, but not necessarily sustained monotonic falls, in asset prices. This notion of price dynamics is consistent with existing understanding of market crashes, which allows for a mix of market responses that are not universally negative. The model may be interpreted as a martingale composed with a randomized drift process that is designed to capture various asymmetric drivers of market sentiment. In particular, the model is capable of generating realistic patterns of price meltdowns and bond yield inflations that constitute major market reversals while not necessarily being always monotonic in form. The recursive and moving window methods developed in Phillips, Shi and Yu (2015, PSY), which were designed to detect exuberance in financial and economic data, are shown to have detective capacity for such meltdowns and expansions. This characteristic of the PSY tests has been noted in earlier empirical studies by the present authors and other researchers but no analytic reasoning has yet been given to explain why methods intended to capture the expansionary phase of a bubble may also detect abrupt and broadly sustained collapses. The model and asymptotic theory developed in the present paper together explain this property of the PSY procedures. The methods are applied to analyze S\&P500 stock prices and sovereign risk in European Union countries over 2001-2016 using government bond yields and credit default swap premia. A pseudo real-time empirical analysis of these data shows the effectiveness of the monitoring strategy in capturing key events and turning points in market risk assessment.
    Keywords: Collapse, Crash, Exuberance, Recursive test, Rolling test, Sovereign risk
    JEL: C23
    Date: 2017–09
  15. By: Feld, Lars P.; Köhler, Ekkehard A.; Wolfinger, Julia
    Abstract: In this paper, we extend Henning Bohn's (2008) fiscal sustainability test by allowing for slope heterogeneity and cross-sectional dependence (CD). In particular, our econometric approach is the first that allows fiscal reaction functions (FRF) to capture unobserved heterogeneous effects from business and fiscal policy cycles. We apply this econometric approach to sub-national public finance data of the German Laender between 1950 and 2015 and find that their fiscal policy only partly meets fiscal sustainability criteria. According to our results, politicians have significantly reacted to increasing debt levels by increasing budget surpluses since 1991. However, time-series evidence for longer periods does not indicate a significant and positive reaction to increasing debt levels in the West German Laender panel.
    Keywords: Fiscal Sustainability,Public Debt,Panel Data,Cross-Sectional Dependence
    JEL: H62 H77 H72 C23
    Date: 2018
  16. By: Jeromin Zettelmeyer (Peterson Institute for International Economics); Emilios Avgouleas (University of Edinburgh); Barry Eichengreen (University of California, Berkeley); Miguel Poiares Maduro (European University Institute, Florence); Ugo Panizza (Graduate Institute, Geneva); Richard Portes (London Business School); Beatrice Weder di Mauro (INSEAD, Singapore); Charles Wyplosz (Graduate Institute, Geneva)
    Abstract: Greece’s debt currently stands at close to €330 billion, over 180 percent of GDP, with almost 70 percent owed to European official creditors. The fact that Greece’s public debts must be restructured is by now widely accepted. What remains controversial, however, is the extent of debt relief needed to make Greece’s debt sustainable. This Policy Brief argues that the debt relief measures outlined by the Eurogroup will not be sufficient to restore the sustainability of Greece’s debt. At the same time it shows that Greece’s debt sustainability can in fact be restored without aggravating moral hazard—i.e., encouraging future governments in Greece and elsewhere in the euro area to take risks in the belief that they will be bailed out—and within the framework of EU law, in particular Article 125 of the Lisbon Treaty, which prohibits EU members from assuming liability for the debts of other members. It concludes that only conditional face value debt relief, in combination with the measures already considered by the Eurogroup, would restore Greece’s debt sustainability with reasonable confidence. Furthermore, if the debt relief is structured in a way that creates incentives for additional fiscal adjustment, as proposed in this Brief, the amount of face value debt relief required could be modest—on the order of 10 to 15 percent of the outstanding official debt.
    Date: 2018–10
  17. By: Maren Brede; Christian Henn
    Abstract: We construct a comprehensive public sector balance sheet for Finland from 2000 to 2016 by complementing general government statistics with data on public corporations and public pensions. We show that exposure to valuation changes in equity markets through asset holdings and increases in pension liabilities relative to GDP amplify crisis impacts on public finances. We expand the balance sheet by including present value estimates of future fiscal flows; this allows us to perform fiscal stress tests and policy experiments. These analyses suggest that Finland’s public finances will remain sound provided ongoing reform and consolidation efforts to address aging pressures are implemented as planned.
    Date: 2018–04–06

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