nep-eec New Economics Papers
on European Economics
Issue of 2018‒06‒25
fourteen papers chosen by
Giuseppe Marotta
Università degli Studi di Modena e Reggio Emilia

  1. The clearing of euro OTC derivatives post Brexit: Why a uniform regulation and supervision of CCPs is essential for European financial stability By Brühl, Volker
  2. The Term Structure of Redenomination Risk By Christian Bayer; Chi Hyun Kim; Alexander Kriwoluzky
  3. The Micro-Foundations of an Open Economy Money Demand: An Application to the Central and Eastern European Countries By Claudiu Tiberiu Albulescu; Dominique Pépin; Stephen M. Miller
  4. "Exchange rate risk" within the European Monetary Union? Analyzing the exchange rate exposure of German firm By Entrop, Oliver; Merkel, Matthias F.
  5. On the Efficiency of Social Learning By Mengus, Eric; Challe, Edouard; Lopez, Jose Ignacio
  6. Wealth effects in the euro area By Guerrieri, Cinzia; Mendicino, Caterina
  7. On the future of the European Union: Normative derivation and restructuring potential in the new Multiannual Financial Framework By Busch, Berthold; Matthes, Jürgen
  8. Unemployment and Inflation: Evidence of a Nonlinear Phillips Curve in the Eurozone By Ho, Sin-Yu; Njindan Iyke, Bernard
  9. Financial institutions' business models and the global transmission of monetary policy By Isabel Argimón; Clemens Bonner; Ricardo Correa; Patty Duijm; Jon Frost; Jakob de Haan; Leo de Haan; Viktors Stebunovs
  10. Is the European Semester effective and useful? By Konstantinos Efstathiou; Guntram B. Wolff
  11. Lessons for Iceland from the Monetary Policy of Sweden By Andersson, Fredrik N. G.; Jonung, Lars
  12. The unemployment impact of product and labour market regulation: evidence from European countries By Céline Piton; François Rycx
  13. Nominal wage rigidity in the EU countries before and after the Great Recession: evidence from the WDN surveys By Eva Branten; Ana Lamo; Tairi Room
  14. The financial transmission of housing bubbles: evidence from Spain By Alberto Martin; Enrique Moral-Benito; Tom Schmitz

  1. By: Brühl, Volker
    Abstract: With a notional amount outstanding of more than USD 500 trillion, the market for OTC derivatives is of vital importance for global financial stability. A growing proportion of these contracts are cleared via central counterparties (CCPs), which means that CCPs are gaining in importance as critical financial market infrastructures. At the same time, there is growing concern that a new "too big to fail" problem could arise, as the CCP industry is highly concentrated due to economies of scale. From a European perspective, it should be noted that the clearing of euro-denominated OTC derivatives mainly takes place in London, hence outside the EU in the foreseeable future. For some time there has been a controversial discussion as to whether this can remain the case post Brexit. CCPs, which clear a significant proportion of euro OTC derivatives and are systemically relevant from an EU perspective, should be subject to direct supervision by EU authorities and should be established in the EU. This would represent an important building block for a future Capital Markets Union in Europe, as regulatory or supervisory arbitrage in favour of systemically important third-country CCPs could be prevented. In addition, if a systemically relevant CCP handling a considerable portion of the euro OTC derivatives business were to run into serious difficulties, this may impact ECB monetary policy. This applies both to demand for central bank money and to the transmission of monetary policy measures, which can be significantly impaired, particularly in the event that the repo market or payment systems are disrupted. It is therefore essential for the ECB to be closely involved in the supervision of CCPs. Against this background, the draft amendment of EMIR (European Market Infrastructure Regulation) presented on 13 June 2017 is a step in the right direction. In addition, there is an urgent need to introduce a recovery and resolution mechanism for CCPs in the EU to complement the existing single resolution mechanism (SRM) for banks in the eurozone. Only then can the diverse interdependencies between banks and CCPs be adequately taken into account in the recovery and resolution programmes required in a financial crisis.
    JEL: G20 G21
    Date: 2018
  2. By: Christian Bayer; Chi Hyun Kim; Alexander Kriwoluzky
    Abstract: This paper assesses redenomination risk in the euro area. We first estimate daily default-risk-free yield curves for French, German, and Italian bonds that can be redenominated and for bonds that cannot. Then, we extract the compensation for redenomination risk from the yield spreads between these two types of bonds. Redenomination risk primarily shows up at the short end of yield curves. At the height of the euro crisis, spreads between first-year yields were close to 7% for Italy and up to -2% for Germany. The ECB's interventions designed to reduce the risk of a breakup successfully did so for Italy, but increased it for France and Germany.
    Keywords: Euro crisis, redenomination risk, Yield curve, ECB interventions
    JEL: E44 F31 F33 G12 G14
    Date: 2018
  3. By: Claudiu Tiberiu Albulescu (Politehnica University of Timisoara); Dominique Pépin (University of Poitiers); Stephen M. Miller (University of Nevada, Las Vegas)
    Abstract: This paper investigates and compares the effect of currency substitution between the currencies of Central and Eastern European (CEE) countries and the euro on CEE money demand functions. In addition, we develop a model with microeconomic foundations, which identifies the difference between currency substitution and money demand sensitivity to exchange rate variations. More precisely, we posit that currency substitution relates to the money demand sensitivity to interest rate spreads between CEE countries and the euro area. Moreover, we show how the exchange rate affects money demand, even absent a currency substitution effect. This model applies to any country where an international currency offers liquidity services to domestic agents. The model generates empirical tests of long-run money demand using two complementary cointegrating equations. The opportunity cost of holding the money and the scale variable, either household consumption or output, explain the long-run money demand in CEE countries.
    Keywords: Money demand; Open-economy model; Currency substitution; Cointegration; CEE countries
    JEL: E41 E52 F41
    Date: 2018–06
  4. By: Entrop, Oliver; Merkel, Matthias F.
    Abstract: In this paper we show that inflation differentials among the countries in the European Monetary Union (EMU) are an economically significant risk to German firms, which make up the largest economy in the EMU. This risk can be interpreted as real "exchange rate exposure" resulting from trade within the euro area. Actually, we find that this EMU exposure is nearly as high as the standard exchange rate exposure caused by trade with non-EMU countries. Moreover, our analysis shows that many of the conventional factors that drive firm-specific exchange rate risk, such as size, debt ratio, asset turnover and foreign business activity, also determine EMU exposure in an economically meaningful way. However, EMU exposure challenges firms' risk management, particularly as it cannot be reduced by standard financial hedging instruments, such as currency derivatives.
    Keywords: currency risk,inflation differentials,single-currency area
    JEL: F23 F31 G15
    Date: 2018
  5. By: Mengus, Eric; Challe, Edouard; Lopez, Jose Ignacio
    Abstract: This paper analyzes, empirically and theoretically, the link between capital inflows and the quality of economic institutions. Starting with the example of Southern European countries (Spain, Portugal, Italy and Greece), we show that they experienced a significant decline in the quality of their institutions in the run-up to the euro currency, a period of cheap external funding and large capital inflows. We confirm this joint pattern of capital flows and institutional decline in a large panel of countries since the mid-1990s. We then develop an open-economy model of the "soft budget constraint" syndrome wherein persistently cheap funding from abroad (i) raises the prevalence of extractive projects and (ii) expands their support by the (benevolent) government ex post. While the government may in principle limit the prevalence of extractive projects ex ante, we show that the incentives to do so is limited when foreign borrowing is cheap.
    Keywords: Institutions; current account
    JEL: E02 F33 G15
    Date: 2019–01–19
  6. By: Guerrieri, Cinzia; Mendicino, Caterina
    Abstract: How sizable is the wealth effect on consumption in euro area countries? To address this question, we use newly available harmonized euro area wealth data and the methodology in Carroll et al. (2011b). We find that the marginal propensity to consume out of total wealth averaged across the largest euro area economies is around 3 cents per euro, with a marginal propensity to consume out of financial wealth significantly larger than of housing wealth. Country-group estimates document no significant differences between the largest economies and the rest of the sample. In contrast, remarkable differences emerge between periphery and core countries. JEL Classification: C22, E21, E32, E44
    Keywords: consumption dynamics, financial assets, households wealth, wealth effects
    Date: 2018–06
  7. By: Busch, Berthold; Matthes, Jürgen
    Abstract: The debate concerning the future of the EU has been in full swing ever since Emmanuel Macron’s (2017) Sorbonne speech. New threats to internal and external security in Europe require a stronger EU. In addition, Brexit is ripping a hole in the EU finances. This pressure for reform must be used to establish new priorities in the EU budget when discussions are held about the next Multiannual Financial Framework (MFF) 2021-2027. The European Commission has put forward different options for consideration as part of the discussion process, and this study is based on them. It takes the form of a normative review of EU tasks, which has two evaluation criteria: Firstly, there will be a discussion concerning which political areas should be the responsibility of the EU, and which of the member states. Cross-border spillover effects, economies of scale, preference differences and the subsidiarity principle, all have an important role to play when assessing EU added value on the basis of existing criteria and studies. Secondly, various policy fields will be examined to establish whether, and to what extent, they meet Musgrave's three criteria of public finance policy: allocation/growth, distribution/structural change cushioning, macro-economic stabilisation. [...]
    JEL: H61 O52 H41
    Date: 2018
  8. By: Ho, Sin-Yu; Njindan Iyke, Bernard
    Abstract: The classical Phillips curve shows a negative relationship between inflation and unemployment. However, various studies have documented temporal positive and negative relationships between inflation and unemployment, leading to strong criticisms against the Phillips curve. In particular, the triangle approach indicates that the nature of the inflation-unemployment nexus is contingent on the source of the shocks, the length of lagged responses, and the policy response. Similarly, the strong linearity assumption on which the Phillips curve rests may have led to its empirical failure. Prior studies have modelled the possibility of threshold effects in the Phillips curve but no study has established the thresholds of when the relationship switches from negative to positive in the eurozone. This paper addresses this limitation using 11 eurozone countries for the period of January 1999 to February 2017. The paper also estimates both short- and long-run Phillips curves for these countries. We found that, by assuming linearity, there exists a Phillips curve in the short and the long run. We also established that the linearity assumption in the classical Phillips curve might be too strong since there is evidence of threshold effects. The thresholds in unemployment were 5.00% and 6.54%. By estimating the Phillips curve using these thresholds, we found that the relationship between inflation and unemployment is only negative when unemployment is lower than 5.00%. The negative relationship turned positive when unemployment was between 5.00% and 6.54%. Inflation and unemployment are unrelated once a threshold of a 6.54% unemployment rate is surpassed. These findings do not only highlight the importance of threshold effects in the Phillips curve, they also shed light on the need to fight unemployment in the eurozone.
    Keywords: Inflation; Unemployment; Nonlinearity; Phillips Curve; Eurozone.
    JEL: E24 E31
    Date: 2018
  9. By: Isabel Argimón (Banco de España); Clemens Bonner (De Nederlandsche Bank and Vu University Amsterdam); Ricardo Correa (Federal Reserve Board); Patty Duijm (De Nederlandsche Bank); Jon Frost (De Nederlandsche Bank, Vu University Amsterdam and Financial Stability Board); Jakob de Haan (De Nederlandsche Bank, University of Groningen and CESifo); Leo de Haan (De Nederlandsche Bank); Viktors Stebunovs (Federal Reserve Board)
    Abstract: Global financial institutions play an important role in channeling funds across countries and, therefore, transmitting monetary policy from one country to another. In this paper, we study whether such international transmission depends on financial institutions’ business models. In particular, we use Dutch, Spanish, and U.S. confidential supervisory data to test whether the transmission operates differently through banks, insurance companies, and pension funds. We find marked heterogeneity in the transmission of monetary policy across the three types of institutions, across the three banking systems, and across banks within each banking system. While insurance companies and pension funds do not transmit homecountry monetary policy internationally, banks do, with the direction and strength of the transmission determined by their business models and balance sheet characteristics.
    Keywords: monetary policy transmission, global financial institutions, bank lending channel, portfolio channel, business models.
    JEL: E5 F3 F4 G2
    Date: 2018–06
  10. By: Konstantinos Efstathiou; Guntram B. Wolff
    Abstract: The authors study whether and to what extent EU countries implement recommendations on macroeconomic imbalances given by the EU in the so-called European Semester. They assess how recommendations have evolved since 2013, based on a new database. Konstantinos Efstathiou and Guntram B. Wolff also study how EU recommendations on addressing macroeconomic imbalances compare to recommendations given by the International Monetary Fund. Overall implementation of recommendations by EU countries has worsened in the last few years, in particular when it comes to recommendations addressed to countries with excessive macroeconomic imbalances. The policy content of the recommendations is broadly aligned with economic priorities emphasised by their corresponding legal bases, but a sizable share of recommendations, such as childcare, are also labelled as relevant for resolving macroeconomic imbalances. Moreover, for countries with macroeconomic imbalances, the IMF tends to emphasise financial imbalances more frequently than the EU. The authors also note that the EU makes significant political choices about which imbalances are judged to be excessive and which are judged not excessive. Low implementation is likely a result of the fundamental dilemma facing the EU. National policies have major cross-border implications making coordination important, but countries take sovereign decisions mostly based on national considerations. They therefore argue that recommendations given in the context of macroeconomic imbalances should be focused on key issues of macroeconomic and cross-border relevance. Moreover, a significant gap was noted between analyses as described in the recitals of recommendations and the actual recommendations, and would urge greater consistency. Finally, the European Semester exercise is very difficult to digest and communication of key analyses and recommendations could be significantly improved to make them more accessible to national policymakers.
    Date: 2018–06
  11. By: Andersson, Fredrik N. G. (Department of Economics, Lund University); Jonung, Lars (Department of Economics, Lund University)
    Abstract: The purpose of this report is to derive lessons from inflation targeting in Sweden for the choice of the future monetary policy regime of Iceland. Swedish inflation targeting has been a success in terms of reducing inflation and inflation volatility, but real economic volatility is not lower compared to previous periods. In addition, financial imbalances have grown rapidly. A key lesson is that the Riksbank has closely shadowed the policy of the European Central Bank due to financial integration. In other words, the Riksbank has behaved as if Sweden had a fixed exchange rate to the euro. Our analysis clearly indicates that a small economy cannot pursue an independent monetary policy from the rest of the world in a financially integrated world. Consequently, we suggest a fixed exchange rate arrangement for Iceland, preferably through a currency board. A currency board would provide exchange rate and price stability. A currency board would require domestic reforms to enhance price and wage flexibility as well as proper regulations on the financial system to minimize the risk of future banking crises.
    Keywords: Monetary policy; inflation targeting; financial stability; Riksbank; Sweden; Iceland; Central Bank of Iceland
    JEL: E42 E43 E44 E47 E52 E58 E62
    Date: 2018–06–18
  12. By: Céline Piton; François Rycx
    Abstract: This paper provides robust estimates of the impact of both product and labour market regulations on unemployment using data for 24 European countries over the period 1998-2013. Controlling for country-fixed effects, endogeneity and a large set of covariates, results show that product market deregulation overall reduces the unemployment rate. This finding is robust across all specifications and in line with theoretical predictions. However, not all types of reforms have the same effect: deregulation of state controls and in particular involvement in business operations tends to push up the unemployment rate. Labour market deregulation, proxied by the employment protection legislation index, is detrimental to unemployment in the short run while a positive impact (i.e. a reduction of the unemployment rate) occurs only in the long run. Analysis by sub-indicators shows that reducing protection against collective dismissals helps in reducing the unemployment rate. The unemployment rate equation is also estimated for different categories of workers. While men and women are equally affected by product and labour market deregulations, workers distinguished by age and by educational attainment are affected differently. In terms of employment protection, young workers are almost twice as strongly affected as older workers. Regarding product market deregulation, highly-educated individuals are less impacted than low- and middle-educated workers.
    Keywords: Unemployment; Structural reform; Product market; Labour market; Regulation; Employment Protection
    JEL: E24 E60 J48 J64 L51
    Date: 2018–06–04
  13. By: Eva Branten; Ana Lamo; Tairi Room
    Abstract: This paper studies the recent trends in nominal wage rigidity in a large group of EU countries, using survey data. We analyse two forms of nominal wage rigidity: downward nominal wage rigidity (DNWR) and the lagged response of wages to shocks. The frequency of wage changes, which is an indicator of lagged wage setting, slowed down in the aftermath of the Great Recession. We assess the possible reasons for this, and show that it was at least partially caused by a combination of a decline in average wage growth and persistent DNWR. In countries where wage growth slowed down more after the Great Recession, the frequency of wage changes declined more steeply as well. Our data allows evaluating the prevalence of DNWR in diverse economic circumstances. Like earlier research on this topic, we find that DNWR tends to be strongly prevalent, even in periods of slow economic growth and low wage inflation. DNWR declines during severe recessions but even then wage setting does not become completely flexible as the proportion of observed wage cuts is still below the level that would correspond to a flexible regime.
    Keywords: downward nominal wage rigidity, wage change frequency, survey
    JEL: B41 D22
    Date: 2018–06–15
  14. By: Alberto Martin; Enrique Moral-Benito; Tom Schmitz
    Abstract: What are the effects of a housing bubble on the rest of the economy? We show that if firms and banks face collateral constraints, a housing bubble initially raises credit demand by housing firms while leaving credit supply unaffected. It therefore crowds out credit to non-housing firms. If time passes and the bubble lasts, however, housing firms eventually pay back their higher loans. This leads to an increase in banks’ net worth and thus to an expansion in their supply of credit to all firms: crowding-out gives way to crowding-in. These predictions are confirmed by empirical evidence from the recent Spanish housing bubble. In the early years of the bubble, non-housing firms reduced their credit from banks that were more exposed to the bubble, and firms that were more exposed to these banks had lower credit and output growth. In its last years, these effects were reversed.
    Keywords: Housing bubble, credit, investment, financial frictions, financial transmission, Spain
    JEL: E32 E44 G21
    Date: 2018–06

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