nep-eec New Economics Papers
on European Economics
Issue of 2018‒12‒24
eighteen papers chosen by
Giuseppe Marotta
Università degli Studi di Modena e Reggio Emilia

  1. International bank flows and bank business models since the crisis By Herzberg, Valerie; McQuade, Peter
  2. A Better European Architecture to Fight Money Laundering By Joshua Kirschenbaum; Nicolas Veron
  3. International spillovers of monetary policy: evidence from France and Italy By Caccavaio, Marianna; Carpinelli, Luisa; Marinelli, Giuseppe; Schmidt, Julia
  4. Quantifying Brexit: From Ex Post to Ex Ante Using Structural Gravity By Gabriel Felbermayr; Jasmin Katrin Gröschl; Marina Steininger
  5. Forecast errors and monetary policy normalisation in the euro area By Zsolt Darvas
  6. A macro-financial analysis of the corporate bond market By Dewachter, Hans; Iania, Leonardo; Lemke, Wolfgang; Lyrio, Marco
  8. Short-time work in the Great Recession: Firm-level evidence from 20 EU countries By Reamonn Lydon; Thomas Y. Mathä; Stephen Millard
  9. 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 Florian Urbschat
  10. Home Ownership and Monetary Policy Transmission By Koeniger, Winfried; Ramelet, Marc-Antoine
  11. Does the Deregulation of the Labour Market Reduce Employment Hysteresis? An Analysis in a Low Interest Rate Environment By Paulo R. Mota; Paulo B. Vasconcelos
  12. The euro as an international currency By Konstantinos Efstathiou; Francesco Papadia
  13. What Option Prices tell us about the ECB's Unconventional Monetary Policies By Stan Olijslagers; Annelie Petersen; Nander de Vette; Sweder (S.J.G.) van Wijnbergen
  14. Gambling traps By Ari, Anil
  15. The natural rate of interest: estimates, drivers, and challenges to monetary policy JEL Classification: E52, E43 By Brand, Claus; Bielecki, Marcin; Penalver, Adrian
  16. Recent trends in economic activity and TFP in Italy with a focus on embodied technical progress By Alessandro Mistretta; Francesco Zollino
  17. The PEPP could become the new UCITS By Lannoo, Karel
  18. Is ECB monetary policy more powerful during expansions? By Martina Cecioni

  1. By: Herzberg, Valerie (Central Bank of Ireland); McQuade, Peter (Central Bank of Ireland)
    Abstract: Developments in cross-border banking and bank business models have implications for international risk sharing. During the European sovereign debt crisis, cross-border banks only provided limited risk sharing and even amplified shocks in some euro area Member States. Policymakers responded by introducing an array of prudential instruments to improve bank resilience. This successfully strengthened the euro area banking system, fostering certain bank business models while disincentivising others. Euro area banks are now: (i) more domestically oriented with less cross-border activity; (ii) smaller; (iii) less trading, more lending oriented; (iv) more deposit funded. Conservative business models have advantages from a financial stability perspective, but they may also mitigate the advantages of cross-border activities for banks and the economy. Reforms may be necessary if banks are to play a greater role as a shock absorber in the European banking union.
    Date: 2018–08
  2. By: Joshua Kirschenbaum (German Marshall Fund); Nicolas Veron (Peterson Institute for International Economics)
    Abstract: Major banks or financial institutions in more than 15 countries in the European Union (EU) have been hit in recent years by revelations involving violations of anti–money laundering (AML) laws. These cases have underlined the serious shortcomings of the European Union’s AML regime. AML supervision of banks and other firms rests largely with the national authorities of individual EU member states, in increasing tension with the legal framework for centralized prudential supervision within the euro area and the European single market. The system depends heavily on small, lower-capacity jurisdictions to provide the first line of defense against illicit financial practices, encouraging illicit actors to seek out weak links. The result is an erosion of supervisory effectiveness in those member states where money launderers concentrate their activity, undermining the integrity of the entire European system. This study recommends the creation of a European AML Authority that would supervise banks, other financial institutions, and nonfinancial firms for AML purposes. The new agency should have high standards of governance and independence, publish all of its decisions, and be empowered to impose sufficiently large fines to deter malpractice.
    Date: 2018–12
  3. By: Caccavaio, Marianna; Carpinelli, Luisa; Marinelli, Giuseppe; Schmidt, Julia
    Abstract: In this paper we provide empirical evidence on the impact of US and UK monetary policy changes on credit supply of banks operating in Italy and France over the period 2000–2015, exploring the existence of an international bank lending channel based on the reliance on funding sources located in these two countries or denominated in their currency. We find that US monetary policy tightening leads to a reduction of lending to the domestic economy in both France and Italy, and this is mainly driven by banks that relied more intensely on USD funding markets. Conversely, we find that both French and Italian banks are isolated from UK monetary policy shocks, as most of their UK funding is denominated in Euro, despite being larger than funding from the US. JEL Classification: E51, F30, F42, G20
    Keywords: bank lending channel, foreign funding, global banks
    Date: 2018–12
  4. By: Gabriel Felbermayr; Jasmin Katrin Gröschl; Marina Steininger
    Abstract: Exploiting changes in the geography of economic integration in Europe, this paper uses detailed bilateral trade data for 50 sectors to carry out an econometric ex post evaluation of the trade cost effects of the United Kingdom’s various arrangements with the European Union. The analysis reveals important heterogeneity across agreements, sectors, and within pairs. In particular, the EU’s eastward enlargement or the EU-Korea trade agreement have lowered the UK’s outward trade costs only relatively modestly. These asymmetries matter for the size and distribution of the welfare effects of Brexit – the withdrawal of the UK from EU agreements resulting into a return of trade costs to the situation quo ante. We make this point with the help of a modern multi-sector trade model that is able to capture inter- and intranational production networks. In line with other papers, the welfare costs of Brexit are higher in the UK than in most other EU countries. However, the considered asymmetries tend to attenuate overall costs while giving rise to substantial heterogeneity between EU27 members and sectors.
    Keywords: structural gravity, European trade integration, general equilibrium, quantitative trade models, Brexit
    JEL: F15 F17 N74
    Date: 2018
  5. By: Zsolt Darvas
    Abstract: This Policy Contribution was prepared for the Nomura Foundation’s Macro Economy Research Conference - ‘Monetary Policy Normalization Ten Years after the Great Recession’, 24 October 2018, Tokyo. Financial support from the Nomura Foundation is gratefully acknowledged. We consider the lessons of the recent monetary policy normalisation experiences of Sweden, the United States and the United Kingdom, and analyse the European Central Bank’s forecasting track record and possible factors that might explain the forecast errors. From this analysis, we draw the following main conclusions - Monetary tightening involves major risks when the evidence of an improved inflation outlook is not sufficiently strong; it is better to err on the side of a possible inflation overshoot after a long period of undershooting; Inadequate forward guidance can cause market turbulence; Market participants might disregard forward guidance after large systematic forecast errors; Terminating net asset purchases might not increase long-term rates, though it might have an impact on other asset prices because of the lack of portfolio rebalancing; The ECB has made huge and systematic forecasting errors in the past five years, indicating that some of the behavioural relationships in ECB forecasting models are mis-specified. The ECB is not the only institution to suffer from incorrect forecasts and there should be broader debate on forecasting practices. However, the ECB’s forecast errors and its inability to lift core inflation above 1 percent have major implications; Market-based inflation expectations have already started to fall in the euro area, suggesting that the trust has weakened in the ECB’s ability to reach its inflation aim of the below but close to two percent over the medium term; More time is needed to see if the forecasting failures of the past five years were driven by factors whose impact will gradually fade away, or if the ECB’s ability to lift core inflation has been compromised; In the meantime, a very cautious approach to monetary policy normalisation is recommended. A rate increase is only recommended after a significant increase in actual core inflation. This intention should be made clear in the ECB’s forward guidance; If forecasting failures continue and core inflation does not approach two percent, the ECB’s credibility could be undermined, making necessary a discussion on either the deployment of new tools to influence core inflation, or a possible revision of the ECB’s inflation goal; In the new ‘normal’ the natural rate of interest might remain low, and thereby central bank balance sheet policies will likely became part of the regular toolkit; Monetary policy tools are ill-suited to address financial stability concerns in general, especially in the euro area. Financial stability concerns should not play a role in monetary policy normalisation. Instead, country-specific macroprudential policy should complement micro-prudential supervision and regulation.
    Date: 2018–12
  6. By: Dewachter, Hans; Iania, Leonardo; Lemke, Wolfgang; Lyrio, Marco
    Abstract: We assess the contribution of economic and financial factors in the determination of euro area corporate bond spreads over the period 2001-2015. The proposed multi-market, no-arbitrage affine term structure model is based on the methodology proposed by Dewachter, Iania, Lyrio, and Perea (2015). We model jointly the ‘risk-free curve’, measured by overnight index swap (OIS) rates, and the corporate yield curves for two rating classes (A and BBB). The model includes four spanned and six unspanned factors. We find that, in general, both economic (real activity and inflation) and financial factors (proxying risk aversion, flight to liquidity and general financial market stress) play a significant role in the determination of the spanned factors and hence in the dynamics of the risk-free yield curve and corporate bond spreads. Across the risk-free OIS curve, macroeconomic and financial factors are each responsible on average for explaining 30 and 65 percent of yield varation, respectively. For A- and BBB-rated corporate debt, the selected financial variables explain on average 50 percent of the variation in corporate spreads during the last decade. JEL Classification: E43, E44
    Keywords: euro area corporate bonds, unspanned macro factors, yield spread decomposition
    Date: 2018–12
  7. By: Paulo R. Mota (University of Porto – School of Economics and Business and CEF.UP); Abel L. C. Fernandes (University of Porto – School of Economics and Business and NIFIP); Paulo B. Vasconcelos (University of Porto – School of Economics and Business and CMUP)
    Abstract: The austerity policy applied by the Eurozone peripheral governments under the International Monetary Fund (IMF)/ European Central Bank (ECB)/ European Commission financial assistance programs has contributed to a sharp reduction of aggregate demand, regardless of the unconventional measures undertaken by the ECB. The ECB decreased the interest rate on the main refinancing operations to zero, and is buying assets from banks on a massive scale under the Expanded Asset Purchase Programme. The fact that these extraordinary measures have not been enough to produce a strong recovery, shifts the focus again to fiscal policy. Central to assessing the effects of fiscal policy are the value of impact fiscal multipliers and the size of hysteretic effects. There is widespread evidence that public expenditure multipliers are greater than one when the economy is depressed and the interest rates are close to zero. However, less is known about the importance of hysteresis effects. Using the linear play model of hysteresis we find that hysteresis effects are important in the Eurozone peripheral countries. Large fiscal impact multipliers combined with the presence of hysteresis implies that front-loaded austerity depresses the economy in the short run and these effects may persist in the long run.
    Keywords: Employment, fiscal multipliers, hysteresis
    JEL: E24 E62 J23
    Date: 2018–12
  8. By: Reamonn Lydon; Thomas Y. Mathä; Stephen Millard
    Abstract: Using firm-level data from a large-scale European survey among 20 countries, we analyse the determinants of firms using short-time work (STW). We show that firms are more likely to use STW in case of negative demand shocks. We show that STW schemes are more likely to be used by firms with high degrees of firm-specific human capital, high firing costs, and operating in countries with stringent employment protection legislation and a high degree of downward nominal wage rigidity. STW use is higher in countries with formalised schemes and in countries where these schemes were extended in response to the recent crisis. On the wider economic impact of STW, we show that firms using the schemes are significantly less likely to lay off permanent workers in response to a negative shock, with no impact for temporary workers. Relating our STW take-up measure in the micro data to aggregate data on employment and output trends, we show that sectors with a high STW take-up exhibit significantly less cyclical variation in employment.
    Keywords: Firms, survey, crisis, short-time work, wages, recession.
    JEL: C25 E24 J63 J68
    Date: 2018–12
  9. By: Florian Urbschat
    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
  10. By: Koeniger, Winfried (University of St. Gallen); Ramelet, Marc-Antoine (University of St. Gallen)
    Abstract: We present empirical evidence on the heterogeneity in monetary policy transmission across countries with different home ownership rates. We use household-level data together with shocks to the policy rate identified from high-frequency data. We find that housing tenure reacts more strongly to unexpected changes in the policy rate in Germany and Switzerland - the OECD countries with the lowest home ownership rates - compared with existing evidence for the U.S. An unexpected decrease in the policy rate by 25 basis points increases the home ownership rate by 0.8 percentage points in Germany and by 0.6 percentage points in Switzerland. The response of non-housing consumption in Switzerland is less heterogeneous across renters and mortgagors, and has a different pattern across age groups than in the U.S. We discuss economic explanations for these findings and implications for monetary policy.
    Keywords: monetary policy transmission, home ownership, housing tenure, consumption
    JEL: E21 E52 R21
    Date: 2018–11
  11. By: Paulo R. Mota (University of Porto – School of Economics and Business and CEF.UP); Paulo B. Vasconcelos (University of Porto – School of Economics and Business and CMUP)
    Abstract: This paper analysis the effects of deregulation of the employment in an environment of low interest rates and economic uncertainty. For this purpose, we estimate a switching employment equation based on the play model of hysteresis. As a novel feature, the estimation allows for a possible change in the value of the switching parameter after the application of labour market reforms. We use Portuguese monthly data spanning from January 2000 to October 2016. Portugal provides a good case study since it is a country where significant measures towards the deregulation of the labour market were applied after the recent financial crises. The results show that these measures reduced the hysteresis effects in the dynamics of aggregate employment except in the period where uncertainty increased substantially.
    Keywords: employment, hysteresis, uncertainty, employment protection legislation
    JEL: E24 J23
    Date: 2018–12
  12. By: Konstantinos Efstathiou; Francesco Papadia
    Abstract: Two questions should be answered in relation to the international role of the euro - is a more important international role for the euro worth pursuing, and what measures would achieve this result, if it is worth pursuing? The most significant benefit for the euro area if the euro played an increased international role would be less dependence on the dollar and a reduced ability of the United States to pursue its political objectives, which are possibly inconsistent with European Union objectives. Historically, international functions have been shared between currencies and the international weights of currencies have evolved according to a limited number of variables. The most important of these are the economic size of the issuing country, the level of development and stability of the underlying financial market, openness to capital movements, a policy stance that encourages currency internationalisation, and political and military power. With the exception of financial stability, these factors do not vary substantially in the short run and give rise to persistent, long-term trends. Thus, in the first twenty years of its existence, the euro has consistently been the second most used international currency, while the dollar has maintained the first position it has held since the second world war. The gap between the dollar and the euro is greatest in the invoicing of commodity trade and as vehicle for foreign exchange transactions, and smallest in cross-border payments. While the ranking of the dollar and the euro has not changed, the euro’s share has fluctuated, particularly in its use in international finance, in correlation with the stability of the euro financial market. This has confirmed that a necessary condition for the euro to play a greater international role is the stability of the euro-area financial system. In addition, the completion of banking union, progress on capital markets union, the issuance of a common bond, and more generally the completion of the institutional architecture of the euro area and progress on a common foreign and defence policy, would promote a wider role for the euro. The European Central Bank should also move beyond its neutral attitude towards the international use of the euro. Most of these policies would have effects well beyond the international use of the euro and, while in principle desirable, are not easy to achieve. Proposals on the international role of the euro published in December 2018 by the European Commission were the start of a journey rather than a decisive step towards a greater international role for the euro.
    Date: 2018–12
  13. By: Stan Olijslagers (UvA); Annelie Petersen (DNB); Nander de Vette (DNB); Sweder (S.J.G.) van Wijnbergen (UvA, CEPR, DNB)
    Abstract: We use a series of different approaches to extract information about crash risk from option prices for the Euro-Dollar exchange rate, with each step sharpening the focus on extracting more specific measures of crash risk around dates of ECB measures of Unconventional Monetary Policy. Several messages emerge from the analysis. Announcing policies in general terms without precisely describing what exactly they entail does not move asset markets or actually increases crash risk. Also, policies directly focused on changing relative asset supplies do seem to have an impact, while measures aiming at easing financing costs of commercial banks do not.
    Keywords: Quantitative Easing; Unconventional Monetary Policies; Exchange Rate Crash Risk; risk reversals; mixed diffusion jump risk models
    JEL: E44 E52 E58 E65 G12 G13 G14
    Date: 2018–12–06
  14. 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 and lead to a “gambling trap” with 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 quantied using Portuguese data and accounts for macroeconomic dynamics in Portugal in 2010-2016. Policy interventions face a trade-off between alleviating banks’ funding conditions and strengthening risk-taking incentives. Liquidity provision to banks may perpetuate gambling traps 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: 2018–12
  15. By: Brand, Claus; Bielecki, Marcin; Penalver, Adrian
    Keywords: demographics, monetary policy, natural rate of interest, productivity growth, return on capital
    Date: 2018–12
  16. By: Alessandro Mistretta (Bank of Italy); Francesco Zollino (Bank of Italy)
    Abstract: In this paper we provide fresh evidence on TFP performance in the Italian economy since 1995, taking into account the changing composition of primary inputs across different capital goods and employment skills, as well as technical progress embodied in different vintages of the productive assets. We first estimate a technical depreciation rate by using individual data on Italian industrial firms. We then obtain an experimental measure of the capital stock adjusted for technical efficiency, by augmenting the standard depreciation rate by our own estimate of technical depreciation (about 5 per cent per year). Once we introduce our measure of capital stock in a standard growth accounting exercise, we find a less dismal performance of the Italian TFP than usually estimated. Focusing on the years between 2007 and 2016, the upward correction in TFP amounts to around 1.5 percentage points in the overall period for the total economy and to about 2.5 percentage points when only considering manufacturing. These findings shed a somewhat more positive light on future TFP developments in Italy, suggesting a more rapid increase of potential output than otherwise estimated. In addition, the efficiency of installed capital might soon return to growth, as the expected recovery of investment results in the replacement of old vintages with new and more technically advanced ones.
    Keywords: TFP, technical progress, embodied technology
    JEL: O3 D24 L60
    Date: 2018–12
  17. By: Lannoo, Karel
    Abstract: The EU is well on its way to agreeing on a new European financial product rule, the Pan-European Pension Product (PEPP). Proposed a year ago, both the Parliament and the Council have finalised their readings, ready to have it adopted before this Parliament steps down. The PEPP is intended to make large-scale portable and cost-efficient savings products available throughout the EU. Over time, this first buy-side financial initiative from the EU under the capital markets union programme could become a significant investment vehicle in support of the EU economy, even overtaking the current UCITS, first adopted in 1985.
    Date: 2018–09
  18. By: Martina Cecioni (Bank of Italy)
    Abstract: This paper tests whether the effects of ECB monetary policy vary over different phases of the business cycle. It uses local projections to estimate the state-dependent impulse responses of economic activity and prices to monetary policy shocks. These are identified through high-frequency financial market responses after Governing Council meetings. While the impact of monetary policy on economic activity is roughly similar during recessions and expansions, prices respond more strongly during booms. The result holds when the state of the economy is based on measures of resource utilization, rather than on GDP growth rates. Nominal wages also respond more strongly to monetary policy during expansions and when there is no slack in the economy. The empirical findings are consistent with the presence of downward rigidity on nominal wages.
    Keywords: monetary policy, business cycle
    JEL: E52 E32
    Date: 2018–12

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