nep-eec New Economics Papers
on European Economics
Issue of 2018‒07‒23
twenty-one papers chosen by
Giuseppe Marotta
Università degli Studi di Modena e Reggio Emilia

  1. Country-specific fiscal reaction functions: what lessons for EMU ? By Amélie BARBIER-GAUCHARD; Nicolas MAZUY
  2. Do Unit Labor Costs Matter? A Decomposition Exercise on European Data By Sophie Piton
  3. On the optimal design of a Financial Stability Fund By Arpad Abraham; Eva Carceles-Poveda; Yan Liu; Ramon Marimon
  4. Lender of Last Resort versus Buyer of Last Resort – Evidence from the European Sovereign Debt Crisis By Viral V. Acharya; Diane Pierret; Sascha Steffen
  5. National debts and government deficits within European Monetary Union: Statistical evidence of economic issues By Mario Coccia
  6. Contagion spillovers between sovereign and financial European sector from a Delta CoVaR approach By Javier Ojea Ferreiro
  7. Which Role for a European Minister of Economy and Finance in a European Fiscal Union? By Zareh Asatryan; Xavier Debrun; Annika Havlik; Friedrich Heinemann; Martin G. Kocher; Roberto Tamborini
  8. An Output Gap Measure for the Euro Area : Exploiting Country-Level and Cross-Sectional Data Heterogeneity By Manuel Gonzalez-Astudillo
  9. The Unemployment Impact of Product and Labour Market Regulation: Evidence from European Countries By Piton, Céline; Rycx, Francois
  10. Recession Probabilities for the Eurozone at the Zero Lower Bound: Challenges to the Term Spread and Rise of Alternatives By Ralf Fendel; Nicola Mai; Oliver Mohr
  11. Brexit trade impacts and Mercosur's negotiations with Europe By Nogues, Julio
  13. Institutional convergence in Europe By Schönfelder, Nina; Wagner, Helmut
  14. Foreign-Law Bonds: Can They Reduce Sovereign Borrowing Costs? By Chamon, Marcos; Schumacher, Julian; Trebesch, Christoph
  15. On the EU-US Current Account By Gabriel Felbermayr; Martin Braml
  16. European banks after the global financial crisis: Peak accumulated losses, twin crises and business models By Leo de Haan; Jan Kakes
  17. Profit shifting by EU banks: evidence from country-by-country reporting By Fatica, Serena; Wildmer, Gregori
  18. Looking through cross-border positions in investment funds: evidence from Italy By Valerio Della Corte; Stefano Federico; Alberto Felettigh
  19. Bank profitability and macroeconomic conditions: are business models different? By Emilia Bonaccorsi di Patti; Francesco Palazzo
  20. Inequality amid income stagnation: Italy over the last quarter of a century By Andrea Brandolini; Romina Gambacorta; Alfonso Rosolia
  21. The Good, the Bad, and the Ugly: Impact of Negative Interest Rates and QE on the Profitability and Risk-Taking of 1600 German Banks By Urbschat, Florian

  1. By: Amélie BARBIER-GAUCHARD; Nicolas MAZUY
    Abstract: This paper deals with heterogeneous fiscal behaviors of euro area countries. We estimate EMU Members States fiscal reaction function using time series approach covering the period 1990 :Q1-2017 :Q2. Among the major lessons from this analysis, three general and striking results are worth highlighting : (1) factors explaining national fiscal reaction function in the short run differ from those in the long run, (2) some explanatory variables seem common to all countries while others only concern a small number of countries and (3) the sign of the impact of these explanatory variables can also differ between the countries. Finally, this paper raises the implications of heterogeneous fiscal policies on the functioning of monetary union and asks the question of fiscal convergence in the euro area.
    Keywords: fiscal reaction functions, euro area, error correction model, heterogeneity.
    JEL: E62 H61 H62 C33 C41
    Date: 2018
  2. By: Sophie Piton (PSE - Paris School of Economics, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique)
    Abstract: From the introduction of the Euro up to the 2008 global financial crisis, macroeconomic imbalances widened among Member States. This divergence took the form of strong differences in the dynamics of unit labour costs. This paper asks why this happened. Is it the result of distortionary public spending, or the consequence of economic integration? To answer this question, this paper builds a theoretical framework that is able to provide a decomposition of unit labour costs growth into various effects of economic integration and policy intervention. Using a novel dataset, it then measures the contribution of each effect to the dynamics of unit labour costs in 12 countries of the Euro area from 1995 to 2014. Results show that trade and financial integration are significant drivers of unit labour costs divergence. Before the global financial crisis, in Greece and Portugal for example, trade and financial integration explain up to 30% of the increase in unit labour costs relative to core countries. On the contrary, distortionary public spending plays a minor role. These results suggest that, in peripheral economies, increasing unit labour costs reflect more the process of real convergence than fiscal profligacy.
    Keywords: economic integration,productivity,structural change,non-tradable sector,macroeconomic imbalances,capital flows,growth accounting,Euro area
    Date: 2018–05
  3. By: Arpad Abraham; Eva Carceles-Poveda; Yan Liu; Ramon Marimon
    Abstract: A Financial Stability Fund set by a union of sovereign countries can improve countries' ability to share risks, borrow and lend, with respect to the standard instrument used to smooth fluctuations: sovereign debt financing. Efficiency gains arise from the ability of the fund to over long-term contingent financial contracts, subject to limited enforcement (LE) and moral hazard (MH) constraints. In contrast, standard sovereign debt contracts are uncontingent and subject to untimely debt roll-overs and default risk. We develop a model of the Financial Stability Fund (Fund) as a long-term partnership with LE and MH constraints. We quantitatively compare the constrained-efficient Fund economy with the incomplete markets economy with default. In particular, we characterize how (implicit) interest rates and asset holdings differ, as well as how both economies react differently to the same productivity and government expenditure shocks. In our economies, "calibrated" to the euro area "stressed countries", substantial efficiency gains are achieved by establishing a well-designed Financial Stability Fund; this is particularly true in times of crisis. Our theory provides a basis for the design of a Fund - for example, beyond the current scope of the Euroepan Stability Mechanism (ESM) - and a theoretical and quantitative framework to assess alternative risk-sharing (shock-absorbing) facilities, as well as proposals to deal with the euro area "debt overhang problem."
    Date: 2018
  4. By: Viral V. Acharya (New York University, Centre for Economic Policy Research (CEPR), and National Bureau of Economic Research (NBER)); Diane Pierret (University of Lausanne and Swiss Finance Institute); Sascha Steffen (Frankfurt School of Finance & Management)
    Abstract: We document channels of monetary policy transmission to banks following two interventions of the European Central Bank (ECB). As a lender of last resort via the long-term refinancing operations (LTROs), the ECB improved the collateral value of sovereign bonds of peripheral countries. This resulted in an elevated concentration of these bonds in the portfolios of domestic banks, increasing fire-sale risk and making both banks and sovereign bonds riskier. In contrast, the ECB’s announcement of being a potential buyer of last resort via the Outright Monetary Transaction (OMT) program attracted new investors and reduced fire-sale risk in the sovereign bond market.
    Keywords: Bank-sovereign nexus, ECB, fire sales, unconventional monetary policy
    JEL: G01 G21 G28
    Date: 2018–05
  5. By: Mario Coccia
    Abstract: This study analyzes public debts and deficits between European countries. The statistical evidence here seems in general to reveal that sovereign debts and government deficits of countries within European Monetary Unification-in average- are getting worse than countries outside European Monetary Unification, in particular after the introduction of Euro currency. This socioeconomic issue might be due to Maastricht Treaty, the Stability and Growth Pact, the new Fiscal Compact, strict Balanced-Budget Rules, etc. In fact, this economic policy of European Union, in phases of economic recession, may generate delay and rigidity in the application of prompt counter-cycle (or acyclical) interventions to stimulate the economy when it is in a downturn within countries. Some implications of economic policy are discussed.
    Date: 2018–06
  6. By: Javier Ojea Ferreiro (Department of Quantitative Economics, Complutense University of Madrid (UCM), Somosaguas, 28223,Spain.)
    Abstract: I examine the evolution of contagion indexes between the European financial sector and the sovereign sector (Austria, Belgium, France, Germany, Italy, Netherlands and Spain) during the European sovereign credit crisis. Contagion indexes, Delta CoVaR and Delta CoES, reflect events associated with extreme left tail returns and interdependencies between defaults different than those observed in tranquil times. These measures reveal very useful information concerning risk management. I use a copula approach with time-varying parameters to capture changes in the tail dependence between returns in the financial and the sovereign sectors. I employ a Switching Markov model to identify the most stressful moments of the contagion indicators. The results point out the emergence of Greek debt crisis on March 2010 and the vulnerable situation of Spain and Italy in summer 2011 as the main periods where the contagion from the sovereign to the financial sector was stronger. The decrease in contagion was gradual since the speech made by the ECB on July 26th,2012. The statistical significance of the change in the contagion indicators is checked using boostrap tests.
    Keywords: CoVaR; Copula; European sovereign credit crisis; systemic risk.
    JEL: G18 G21 G32 G38
    Date: 2018–05
  7. By: Zareh Asatryan; Xavier Debrun; Annika Havlik; Friedrich Heinemann; Martin G. Kocher; Roberto Tamborini
    Abstract: The European Commission has proposed to inaugurate a European Minister of Economy and Finance with the broad purpose of streamlining the complex and fragmented decision-making processes within the European Monetary Union. The Minister would jointly serve as Vice-President of the Commission and President of the Eurogroup, and have the tasks of coordinating budgetary instruments and structural reforms, designing and implementing adequate fiscal policies for the euro area, coordinating the enforcement of the Stability and Growth Pact, among others. This policy report discusses the potential role the Minister could play in the development of the European Fiscal Union. The report lays out the main challenges along the current institutional solutions facing several dimensions of the Fiscal Union, in particular related to fiscal sustainability, macroeconomic shocks, incentives of structural reforms, and the optimum provision of European public goods. The report then discusses whether and to what degree the new European Minister of Economy and Finance can provide appropriate solutions to these challenges for the Fiscal Union.
    Date: 2018
  8. By: Manuel Gonzalez-Astudillo
    Abstract: This paper proposes a methodology to estimate the euro-area output gap by taking advantage of two types of data heterogeneity. On the one hand, the method uses information on real GDP, inflation, and the unemployment rate for each member state; on the other hand, it jointly considers this information for all the euro-area countries to extract an area-wide output gap measure. The setup is an unobserved components model that theorizes a common cycle across euro-area economies in addition to country-specific cyclical components. I estimate the model with Bayesian methods using data for the 19 countries of the euro area from 2000:Q1 through 2017:Q2 and perform model comparisons across different specifications of the output trend. The estimation of the model preferred by the data indicates that, because of negative shocks to trend output during global the financial crisis, output remained slightly above potential in that period, but an output gap of about negative 3½ percent emerged during the European debt crisis. At the end of the sample period, output is estimated to be about 1 percent above potential.
    Keywords: Okun's law ; Output gap ; Phillips curve ; Unobserved components model ; Euro area
    JEL: C13 C32 C52 E32
    Date: 2018–06–22
  9. By: Piton, Céline (National Bank of Belgium); Rycx, Francois (Free University of Brussels)
    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
  10. By: Ralf Fendel; Nicola Mai; Oliver Mohr
    Abstract: This paper examines the recession probabilities for the Eurozone along four different dimensions: First, we identify the best performing indicators for a recession within the next 12 months based on 43 underlying single variables and their different transformations in a benchmark model. We find that a modified version of the yield curve incorporating the shadow interest rate removes the downward rigidity of the front-leg and restores part of the informational content of the term spread at the zero lower bound. However, the best performing single indicator of the benchmark model is Real M1 followed by the Purchasing Managers Index (PMI), the investment grade corporate bond spread and the Terms of Trade. Second, the paper establishes three submodels to increase the lead-time and the stability of recession models: (i) Monetary transmission channels via principal component analysis; (ii) Bivariate regressions to identify paramount combinations; (iii) Unstable surges vis-à-vis the Hodrick-Prescott trend to detect animal spirits and hawkish mistakes. Third, the analysis is extended over various forecasting horizons (6m, 18m and 24m). Fourth, the results are analyzed from the perspective of risk-affine and risk-averse investors.
    Keywords: recession probability, term spread, zero lower bound, ECB, monetary transmission channel, animal spirits
    JEL: E3 E32 E37 E5 E58
    Date: 2018–07–11
  11. By: Nogues, Julio
    Abstract: We estimate that a hard Brexit would reduce UK imports of agro industrial products from the EU by 50% more than double the contraction in imports of other goods (22%). The UK Government has announced that it will substitute the CAP (Common Agricultural Policy) protectionist policies with market-oriented measures and policies that seek to protect the environment. Given Brexit, and given scarce negotiating resources, should Mercosur continue to give the same priority to negotiations with the EU as in recent years? The answer is most likely negative. For a number of reasons discussed in the text we argue that: i) negotiations with the EU are unlikely to deliver market access much in excess of what it has offered so far; ii) unlike these negotiations that have been dragging for around twenty years, there are clear circumstances indicating that an FTA with the UK could be completed in a relatively short period; iii) failing Mercosur to give these talks priority, other countries are more than likely to fill the UK trade gap triggered by Brexit; iv) if other countries do so, it is unlikely that in the future the UK would be willing to offer market access concessions as important as it is likely to do today and, v) the UK is one fifth of the EU GDP so balanced reciprocal concessions should be easier to achieve. What are the stakes at play? We offer back of the envelope estimates indicating that in value terms Mercosur could more than triple its meat exports and close to double its agro industrial exports to the UK within a time horizon that currently appears to be quite concrete and near.
    Keywords: Brexit; Mercosur; agro industry trade
    JEL: F1 F14 F17 Q1
    Date: 2018–06
  12. By: António Afonso; João Jalles
    Abstract: In this paper, we decompose the current account (CA) balance in 19 Euro area countries into cyclical and non-cyclical components. For the period 1999:Q1 to 2015:Q4, we compute income elasticities of imports and of exports via an alternative novel and improved approach by running time-varying coefficient models country-by-country. Then, in a panel set-up (and controlling for country-invariant characteristics), we uncover that terms of trade have a positive effect on both the cyclical and non-cyclical components of the CA, while the Global Financial Crisis, compensation of employees and the employment level have a negative effect on the cyclical component. Moreover, the crisis had a greater impact on the cyclical component of the CA due to movements in the real effective exchange rate. In addition, we find a negative effect of the crisis on the cyclical component of the CA for countries that received financial assistance from the European Union, notably Ireland, Portugal, Spain and Latvia.
    Keywords: current account cyclicality; financial markets; time-varying coefficients
    JEL: C23 F32 G01
    Date: 2018–06
  13. By: Schönfelder, Nina; Wagner, Helmut
    Abstract: This paper applies the statistical concepts of σ-convergence and unconditional β-convergence to institutional development within several country groups hierarchized to the degree of European integration (e.g., euro area). Two sets of indicators are employed to measure institutional development: first, the Worldwide Governance Indicators, and second, the product market regulation indicator of the OECD and the Doing Business distance to frontier indicator of the World Bank. The authors can clearly confirm institutional β-convergence within the EU and its aspirants, which is mainly driven by the new Member States and acceding, candidate, and potential candidate countries. However, euro-area countries converge only in the area of product market and business regulation- not in the area of governance. In fact, the authors show evidence for β-divergence in rule of law within the first twelve euro-area members. Concerning σ-convergence, the results are less clear. Only the EU including the EU aspirants reduced the cross-country variance in all aspects of institutional development.
    Keywords: institutional convergence,governance,product market regulation,business regulation,European integration
    JEL: E02 K20 L50
    Date: 2018
  14. By: Chamon, Marcos; Schumacher, Julian; Trebesch, Christoph
    Abstract: Governments often issue bonds in foreign jurisdictions, which can provide additional legal protection vis-à-vis domestic bonds. This paper studies the effect of this jurisdiction choice on bond prices. We test whether foreign-law bonds trade at a premium compared to domestic-law bonds. We use the euro area 2006-2013 as a unique testing ground, controlling for currency risk, liquidity risk, and term structure. Foreign-law bonds indeed carry significantly lower yields in distress periods, and this effect rises as the risk of a sovereign default increases. These results indicate that, in times of crisis, governments can borrow at lower rates under foreign law.
    Keywords: Sovereign Debt; Creditor Rights; Seniority; Law and Finance
    JEL: F34 G12 K22
    Date: 2018–06
  15. By: Gabriel Felbermayr; Martin Braml
    Abstract: The first part of this short report uses the newest available data from the Bureau of Economic Analysis (BEA), an agency of the US Department of Commerce, to analyse economic relations between the US and the EU. The data is used to decompose the components of the US current account balance, and to analyse the bilateral balance of payments with the European Union, the Euro Zone and Germany. In the second part, we use data provided by Eurostat to mirror US figures. We find enormous discrepancies between what the EU and the US report, particularly with respect to primary income.
    Date: 2018
  16. By: Leo de Haan; Jan Kakes
    Abstract: This paper takes stock of European banks' accumulated losses since 2007 and relates these to bank characteristics. In line with previous studies, we find that large, market-oriented banks were particularly hit by the 2007-2009 global financial crisis whereas smaller, retail-oriented banks weathered these years relatively well. In subsequent years, however, the picture reversed and retail-oriented banks were most affected. Over the entire period, medium-sized banks suffered most losses and often needed state aid. This suggests that measures to contain systemic risk, such as capital surcharges and bail-in requirements, are as relevant for these institutions as they are for the largest banks.
    Keywords: Bank profitability; Business model; Financial crisis
    JEL: G01 G21
    Date: 2018–07
  17. By: Fatica, Serena (European Commission – JRC); Wildmer, Gregori (European Commission – JRC)
    Abstract: We investigate profit shifting by the largest and systemically relevant European multinational banks using new data made available through country-by-country reporting for the financial years 2014-2016. We capture tax incentives for income shifting using a multilateral tax differential between the local tax rate and the tax rates in the other countries where the bank has operations. We find that profits - particularly those recorded in tax havens - are negatively affected by corporate taxation. Moreover, the bulk of income shifting seems to take place among subsidiaries, as foreign-to-foreign tax differences matter significantly more that home-to-foreign differentials. Simulation results suggest that the amount of shifted profits in tax havens is about 38% of true profits. The ratio between shifted and true profits drops to about 7% when selected non havens are considered.
    Keywords: banks, tax havens, regulation, tax avoidance, transparency
    JEL: G21 G28 H26 H87
    Date: 2018–06
  18. By: Valerio Della Corte (Bank of Italy); Stefano Federico (Bank of Italy); Alberto Felettigh (Bank of Italy)
    Abstract: Motivated by the increasingly large weight of foreign investment funds on the portfolio of Italian residents, this paper provides an estimate of the composition, by instrument and by issuer country, of Italy’s portfolio assets after “looking through” cross-border positions in investment funds. Our main findings suggest that removing the statistical opacity arising from cross-border positions in investment funds has a significant impact on the composition of Italy’s portfolio investments. After “looking through” foreign funds’ holdings, the share of debt securities on portfolio assets, which is equal to 40 per cent in the unadjusted data, rises to 75 per cent. The country composition of external portfolio assets also fundamentally changes in the direction of increasing its geographical diversification. The United States becomes Italy’s main destination country; the shares of France, Germany, the United Kingdom and Spain also increase, while that of Luxembourg, where most of the foreign investment funds are domiciled, drastically falls.
    Keywords: asset allocation, home bias, mutual funds, portfolio investment
    JEL: F36 G11
    Date: 2018–06
  19. By: Emilia Bonaccorsi di Patti (Bank of Italy); Francesco Palazzo (Bank of Italy)
    Abstract: The paper investigates the impact of macroeconomic conditions on the profitability of EU banks, by testing for differential effects according to the business model. We group banks into three business models using a hierarchical cluster analysis, and find that using clusters based on the share of assets invested in loans reveals heterogeneity in the sensitivity of bank profitability to economic growth across business models. Our main result is that GDP growth, credit growth and the risk-free yield curve influence profitability as expected, but we also find that the effect of GDP growth is only significant for banks that have a high and medium share of assets invested in loans, and not for banks that hold large portfolios of securities. This difference depends on the impact of growth on asset write downs, especially those on loans and, to a lesser extent, on revenues. The results suggest that studies relating bank profitability to macroeconomic conditions should take the heterogeneity of business models into account.
    Keywords: bank profitability, bank business model, income statement, revenues, net interest income
    JEL: G21
    Date: 2018–06
  20. By: Andrea Brandolini (Bank of Italy); Romina Gambacorta (Bank of Italy); Alfonso Rosolia (Bank of Italy)
    Abstract: The paper analyses the evolution of inequality in Italy from 1989 to 2014, focusing on three business-cycle phases: the 1992 currency crisis, the moderate growth from 1993 to 2007, and the double-dip recession from 2008 to 2013. Data from the national accounts and the Bank of Italy’s Survey on Household Income and Wealth are used. Results show that income inequality, as measured by the Gini coefficient, rose sharply during the recession of the early 1990s but much less during the recent double-dip recession, though the share of people at risk of poverty rose similarly during the two crises. The stability of (synthetic) distributive inequality measures is explained by the fact that the reduction in income during the double-dip recession hit the whole population. Despite this apparent stability, two changes stand out: the widening gap between the young and the elderly and the fact that the deterioration in living conditions was borne wholly by households whose primary earner was foreign born.
    Keywords: inequality, household income distribution
    JEL: D31 E24
    Date: 2018–06
  21. By: Urbschat, Florian
    Abstract: The recent negative interest rate policy (NIRP) and quantitative easing (QE) programme by the ECB have raised concerns about the pass-through of monetary policy. On the one hand, negative rates could lead to declining bank profitability making an expansionary monetary policy contractionary. Also, if interest rates are too low for too long banks could be induced to take too much risky credit. On the other hand, several economists argue that there is nothing special about negative interest rates per se. This paper uses a large micro level data set of the German bank universe to examine how banks behave in this uncharted territory. The evidence found suggests that bank’s business model, i.e. the share of overnight deposits, plays a crucial role. While some banks may benefit in the short run via for instance reduced refinancing costs or lower loan loss provisions, many banks with high deposit ratios face lower net interest income and lower credit growth rates. If continued for too long QE and NIRP erode bank profits for most banks eventually.
    Keywords: Negative Interest Rate Policy; Banks' Profitability; Net Interest Rate Margin; Risk-Taking Channel
    JEL: C53 E43 E52 G11 G21
    Date: 2018–07–09

This nep-eec issue is ©2018 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.