nep-eec New Economics Papers
on European Economics
Issue of 2020‒12‒07
seventeen papers chosen by
Giuseppe Marotta
Università degli Studi di Modena e Reggio Emilia

  1. Interest rate risk and monetary policy normalisation in the euro area By Reghezza, Alessio; Rodriguez d’Acri, Costanza; Pancotto, Livia; Molyneux, Philip
  2. Risk Mitigating versus Risk Shifting: Evidence from Banks Security Trading in Crises By Peydró, José-Luis; Polo, Andrea; Sette, Enrico
  3. The Covid-19 Crisis, Italy and Ms Merkel’s Turnaround: Will the EU Ever be the Same Again? By Luigi Bonatti; Andrea Fracasso
  4. High-frequency monitoring of growth-at-risk By Laurent Ferrara; Matteo Mogliani; Jean-Guillaume Sahuc
  5. Fiscal policy shocks and international spillovers By Ayobami E. Ilori; Juan Paez-Farrell; Christoph Thoenissen
  6. Systemic Risk and the COVID Challenge in the European Banking Sector By Nicola Borri; Giorgio Di Giorgio
  7. The trade impact of the UK’s exit from the EU Single Market By Christine Arriola; Sebastian Benz; Annabelle Mourougane; Frank van Tongeren
  8. Optimal quantitative easing in a monetary union By Serdar Kabaca; Renske Maas; Kostas Mavromatis; Romanos Priftis
  9. The Spanish Labour Market at the Crossroads: COVID-19 Meets the Megatrends By Dolado, Juan J.; Felgueroso, Florentino; Jimeno, Juan F.
  10. Decentralisation of collective bargaining: A path to productivity? By Aglio, Daniele; Di Mauro, Filippo
  11. Optimal simple objectives for monetary policy when banks matter By Laureys, Lien; Meeks, Roland; Wanengkirtyo, Boromeus
  12. A Revisit to Sovereign Risk Contagion in Eurozone with Mutual Exciting Regime-Switching Model By Ge, S.
  13. Liquidity and monetary transmission: a quasi-experimental approach By Miller, Sam; Wanengkirtyo, Boromeus
  14. Debt sustainability when r - g By Sweder van Wijnbergen; Stan Olijslagers; Nander de Vette
  15. Beyond the added-worker and the discouraged-worker effects: the entitled-worker effect By Martín-Román, Ángel L.
  16. Effects of eligibility for central bank purchases on corporate bond spreads By Taneli Mäkinen; Fan Li; Andrea Mercatanti; Andrea Silvestrini
  17. Fire sales by euro area banks and funds: what is their asset price impact? By Mirza, Harun; Moccero, Diego; Palligkinis, Spyros; Pancaro, Cosimo

  1. By: Reghezza, Alessio; Rodriguez d’Acri, Costanza; Pancotto, Livia; Molyneux, Philip
    Abstract: In the current low interest rate environment in the euro area there is potential for a sudden increase in interest rates and heightened interest rate risk (IRR). By using a sample of 81 euro area banks during the period 2014Q4-2018Q1 and a confidential supervisory measure of IRR, this paper identifies which bank-specific characteristics can amplify or weaken the impact of a 200 basis points positive shock in interest rates. We find that banks reliant on core deposits, that hold more floating-interest rate loans and that diversify their lending, either by sector or geography, are less exposed to a positive change in interest rates. Interestingly, we discover that banks that did not exploit the exceptional financing provided by the European Central Bank (ECB) reveal greater IRR exposure. These findings advance the debate on the impact on euro area banking of a possible return to a normalised monetary policy. JEL Classification: E43, E44, E52, G21, F44
    Keywords: balance-sheet determinants, interest rate risk, low interest rate environment, unconventional monetary policies
    Date: 2020–11
  2. By: Peydró, José-Luis; Polo, Andrea; Sette, Enrico
    Abstract: We show that risk mitigating incentives dominate risk shifting incentives in fragile banks. Risk shifting could be particularly severe in banking since it is the most opaque industry and banks are one of the most leveraged corporations with very low skin in the game. To analyze this question, we exploit security trading by banks during financial crises, as banks can easily and quickly change their risk exposure within their security portfolio. However, in contrast with the risk shifting hypothesis, we find that less capitalized banks take relatively less risk after financial market stress shocks. We show this using the supervisory ISIN-bank-month level dataset from Italy with all securities for each bank. Our results are over and above capital regulation as we show lower reach-for-yield effects by less capitalized banks within government bonds (with zero risk weights) or within securities with the same rating and maturity in the same month (which determines regulatory capital). Effects are robust to controlling for the covariance with the existence portfolio, and less capitalized banks, if anything, reduce concentration risk. Further, effects are stronger when uncertainty is higher, despite that risk shifting motives may be then higher. Moreover, three separate tests – based on different accounting portfolios (trading book versus held to maturity), the distribution of capital and franchise value – suggest that bank own incentives, instead of supervision, are the main drivers. Results are confirmed if we consider other sources of balance sheet fragility and different measures of risk-taking. Finally, evidence from the recent COVID-19 shock corroborates findings from the Global Financial Crisis and the Euro Area Sovereign Crisis.
    Keywords: risk shifting,financial crises,securities,bank capital,interbank funding,concentration risk,uncertainty,risk weights,available for sale,held to maturity,trading book,COVID-19
    JEL: G01 G21 G28
    Date: 2020
  3. By: Luigi Bonatti; Andrea Fracasso
    Abstract: The functioning of the Eurozone was irreversibly transformed by the European debt crisis and now, as a consequence of the Covid-19 pandemic, a new and even more devastating crisis has hit the EU. German Chancellor Angela Merkel has abandoned her opposition to substantial intercountry transfers and any form of debt mutualization, a turnaround motivated by the exceptional circumstances brought about by the pandemic. The risk that Italy’s fragile financial, economic and political situation, exacerbated by the current crisis, could destabilize the entire Eurozone in the absence of sizeable external assistance was probably one of the main determinants of the German government’s policy shift. In this policy report, Luigi Bonatti and Andrea Fracasso argue that this move will be insufficient to drive Italy into a sustainable and satisfactory growth path, and it will need further financial support from EU institutions and member states. Should they agree to provide financial assistance to the Eurozone's most vulnerable countries and make permanent what was supposed to be temporary, or expose the zone to a possible implosion?
    Date: 2020
  4. By: Laurent Ferrara; Matteo Mogliani; Jean-Guillaume Sahuc
    Abstract: Monitoring changes in financial conditions provides valuable information on the contribution of financial risks to future economic growth. For that purpose, central banks need real-time indicators to adjust promptly the stance of their policy. We extend the quarterly Growth-at-Risk (GaR) approach of Adrian et al. (2019) by accounting for the high-frequency nature of financial conditions indicators. Specifically, we use Bayesian mixed data sampling (MIDAS) quantile regressions to exploit the information content of both a financial stress index and a financial conditions index leading to real-time high-frequency GaR measures for the euro area. We show that our daily GaR indicator (i) provides an early signal of GDP downturns and (ii) allows day-to-day assessment of the effects of monetary policies. During the first six months of the Covid-19 pandemic period, it has provided a timely measure of tail risks on euro area GDP.
    Keywords: Growth-at-Risk, mixed-data sampling, Bayesian quantile regressions, financial conditions, euro area.
    JEL: C22 E37 E44
    Date: 2020–11
  5. By: Ayobami E. Ilori; Juan Paez-Farrell; Christoph Thoenissen
    Abstract: The domestic and international transmission mechanism of fiscal policy shocks are analysed in large developed economies. Using a Bayesian VAR approach, we find that fiscal expansions are associated with increases in output, private consumption and, in many cases, with an increase in private investment. The terms of trade, which affect the international transmission of fiscal policy shocks, are found to depreciate in response to a fiscal expansion, thus transferring some of the increased domestic purchasing power abroad. A US government spending shock is expansionary for all non-US G7 members. A German government spending shock is expansionary for most, but not all European economies, both within and outside the Euro Area. The dynamics of the BVAR are rationalise using a dynamics stochastic general equilibrium model where heterogeneous households and firms face borrowing constraints.
    Keywords: Fiscal policy, Bayesian VAR, DSGE modelling, International business cycles, spillovers
    JEL: E62 F41 F42
    Date: 2020–11
  6. By: Nicola Borri (LUISS University); Giorgio Di Giorgio (LUISS University)
    Abstract: This paper studies the systemic risk contribution of a set of large publicly traded European banks. Over a sample covering the last twenty years and three different crises, we find that all banks in our sample significantly contribute to systemic risk. Moreover, larger banks and banks with a business model more exposed to trading and financial market volatility, contribute more. In the shorter sample characterized by the Covid-19 shock, sovereign default risks significantly affected the systemic risk contribution of all banks. However, the ECB announcement of the Pandemic Emergency Purchasing Programme restored calm in the European banking sector.
    Keywords: CoVaR, systemic risk, Covid-19, banking regulation
    JEL: G01 G18 G21 G38
    Date: 2020–10
  7. By: Christine Arriola; Sebastian Benz; Annabelle Mourougane; Frank van Tongeren
    Abstract: This paper quantifies the sectoral trade impact in the United Kingdom and in EU countries of the UK’s exit from the Single Market, using the OECD general-equilibrium METRO model. A comprehensive free-trade agreement could lead to a fall by about 6.1% of UK exports and 7.8% of UK imports in the medium term compared to a situation where the United Kingdom would stay in the Single Market. Cost would come essentially from rising technical barriers and sanitary and phytosanitory measures on goods and rising trade costs on services. Rules of origin and border transition costs would have a small effect. Output losses in the European Union (0.4-0.5%) are expected to be less pronounced, but would vary markedly across individual countries. Ireland would experience the largest losses. Losses would also vary across sectors. Accounting for the regulatory impact of ending free movement of people for EU nationals on services trade is expected to bring some additional costs to the services economy. Those losses could be partly compensated by growth-enhancing changes to UK regulations, but only to a limited extent.
    Keywords: Brexit, free-trade agreement, general-equilibrium model
    JEL: C68 F15 F47
    Date: 2020–11–23
  8. By: Serdar Kabaca; Renske Maas; Kostas Mavromatis; Romanos Priftis
    Abstract: This paper explores the optimal allocation of government bond purchases within a monetary union, using a two-region DSGE model, where regions are asymmetric with respect to economic size and portfolio characteristics: the extent of substitutability between assets of different maturity and origin, asset home bias, and steady-state levels of government debt. An optimal quantitative easing (QE) policy under commitment does not only reflect different region sizes, but is also a function of these dimensions of portfolio heterogeneity. By calibrating the model to the euro area, we show that optimal QE favors purchases from the smaller region (Periphery instead of Core), given that the former faces stronger portfolio frictions. A fully optimal policy consisting of both the short-term interest rate and QE lifts the monetary union away from the zero lower bound faster than an optimal interest rate policy alone, which entails forward guidance.
    Keywords: Optimal monetary policy; quantitative easing; monetary union; DSGE model; portfolio rebalancing; zero lower bound
    JEL: E43 E52 E58 F45
    Date: 2020–11
  9. By: Dolado, Juan J. (Universidad Carlos III de Madrid); Felgueroso, Florentino (FEDEA, Madrid); Jimeno, Juan F. (Bank of Spain)
    Abstract: This paper reviews the experience so far of the Spanish labour market during the Covid-19 crisis in the light of current institutions, past performance during recessions, and the policy measures adopted during the pandemic. Emphasis is placed on the role of worldwide trends in labour markets (automation and AI) in shaping a potential recovery from this (hopefully) transitory shock through a big reallocation process of employment and economic activity.
    Keywords: epidemic, COVID-19, dual labour markets, flows, recessions
    JEL: J64 J68
    Date: 2020–11
  10. By: Aglio, Daniele; Di Mauro, Filippo
    Abstract: Productivity developments have been rather divergent across EU countries and particularly between Central Eastern Europe (CEE) and elsewhere in the continent (non-CEE). How is such phenomenon related to wage bargaining institutions? Starting from the Great Financial Crisis (GFC) shock, we analyse whether the specific set-up of wage bargaining prevailing in non-CEE may have helped their respective firms to sustain productivity in the aftermath of the crisis. To tackle the issue, we merge the CompNet dataset - of firm-level based productivity indicators - with the Wage Dynamics Network (WDN) survey on wage bargaining institutions. We show that there is a substantial difference in the institutional set-up between the two above groups of countries. First, in CEE countries the bulk of the wage bargaining (some 60%) takes place outside collective bargaining schemes. Second, when a collective bargaining system is adopted in CEE countries, it is prevalently in the form of firm-level bargaining (i. e. the strongest form of decentralisation), while in non-CEE countries is mostly subject to multi-level bargaining (i. e. an intermediate regime, only moderately decentralised). On productivity impacts, we show that firms' TFP in the non-CEE region appears to have benefitted from the chosen form of decentralisation, while no such effects are detectable in CEE countries. On the channels of transmission, we show that decentralisation in non-CEE countries is also negatively correlated with dismissals and with unit labour costs, suggesting that such collective bargaining structure may have helped to better match workers with firms' needs.
    Keywords: total factor productivity,firm-level contracts,multi-level contracts,centralised contracts,unit labour costs,dismissals
    JEL: J30 J51
    Date: 2020
  11. By: Laureys, Lien (Bank of England); Meeks, Roland (International Monetary Fund); Wanengkirtyo, Boromeus (Bank of England)
    Abstract: We reconsider the design of welfare-optimal monetary policy when financing frictions impair the supply of bank credit, and when the objectives set for monetary policy must be simple enough to be implementable and allow for effective accountability. We show that a flexible inflation targeting approach that places weight on stabilising inflation, a measure of resource utilisation, and a financial variable produces welfare benefits that are almost indistinguishable from fully-optimal Ramsey policy. The macro-financial trade-off in our estimated model of the euro area turns out to be modest, implying that the effects of financial frictions can be ameliorated at little cost in terms of inflation. A range of different financial objectives and policy preferences lead to similar conclusions.
    Keywords: Monetary policy; simple loss function; banks; medium-scale DSGE models; euro area economy
    JEL: E17 E52 E58 G21
    Date: 2020–11–20
  12. By: Ge, S.
    Abstract: This paper proposes a new mutual exciting regime-switching model where crises can spread contagiously across countries. Each country has its own hidden stochastic process that determines whether the country is in a normal or crisis regime. Contagion is defined as a rise in the transition probability to the crisis regime when other countries are in crisis in the past state. Using this new approach, I revisit the sovereign risk contagion in the euro area. I find that there are striking shifts in market pricing functions for the sovereign bond spreads. Multi-country contagion plays a dominant role in driving such shifts, while common risk factors and country-specific fundamentals are much less important.
    Keywords: Contagion, Inter-dependence, Regime-switching, Mutual excitation, Sovereign credit risk
    JEL: C10 C58 F36 G12 G15
    Date: 2020–11–26
  13. By: Miller, Sam (Alan Turing Institute); Wanengkirtyo, Boromeus (Bank of England)
    Abstract: In the face of lower real interest rates, central bank balance sheets are likely to remain larger relative to pre-crisis levels, resulting in greater banking system liquidity. However, there is little evidence on the impact of higher liquidity on credit supply and the monetary transmission mechanism in the ‘new normal’. We exploit a novel dataset on bank liquidity positions arising from a unique regulatory regime and combine it with a highly-detailed, loan-level administrative dataset on UK mortgages. Using the design of quantitative easing auctions as an instrument for liquidity to address endogeneity, we find that more liquid banks charge slightly higher mortgage interest rates, and pass on significantly less changes in risk-free rates. We explain this through bank behaviour that attempts to preserve net interest margins in the face of holding low-yielding liquidity. Consistent with this, we find excess liquidity leads to reaching-for-yield responses in banks’ mortgage risk-taking. Additionally, the results shed light on the optimal mix between (un)conventional monetary policy tools. Policies that boost bank net interest margins are more likely to help the transmission of risk-free rates to lending rates.
    Keywords: Bank liquidity; interest rate pass-through; monetary policy
    JEL: E52 E58 G21
    Date: 2020–11–20
  14. By: Sweder van Wijnbergen (University of Amsterdam); Stan Olijslagers (University of Amsterdam); Nander de Vette (De Nederlandsche Bank)
    Abstract: Interest rates on public debt have for several years now fallen short of GDP growth rates in much of the Western world. In his presidential address to the AEA Blanchard argued that this implies that there are no fiscal costs to high debt (Blanchard, 2019). In this paper we argue that the safe rate is not the right interest rate to use for that comparison. We develop a General Equilibrium Asset Pricing model and econometrically estimate the relevant characteristics of the stochastic processes driving the primary surplus in relation to the growth rate of aggregate consumption and derive the proper risk premium. The resulting interest rate exceeds the growth rate. We then calculate the discounted value of future primary surpluses using the same stochastic process for the primary surplus and compare that to the market value of the (Dutch) public sector debt. We test various explanations for the gap between these two and derive the fiscal adjustment necessary to eliminate it (the "fiscal sustainability gap").
    Keywords: Debt valuation, sustainable deficits, fiscal adjustment gap
    JEL: H6 H62 G12
    Date: 2020–11–24
  15. By: Martín-Román, Ángel L.
    Abstract: This paper identifies and analyses a new effect related to the cyclical behavior of labor supply: the Entitled-Worker Effect (EWE). This effect is different from the well-known Added-Worker Effect (AWE) and Discouraged-Worker Effect (DWE). The EWE is a consequence of one of the most important labor institutions: the unemployment benefit (UB). We develop a model with uncertainty about the results of the job seeking and transactions costs linked to such a search process in which a kind of moral hazard appears. This creates new incentives for workers and produces an additional counter-cyclical pressure on aggregate labor supply, but with a different foundation from that of the AWE. Finally, we show some empirical evidence supporting the EWE for the Spanish case.
    Keywords: Labor force participation,Business Cycle,Unemployment,Added-worker effect,Discouraged-worker effect,Unemployment Benefit
    JEL: E24 E32 H55 J22 J64 J65
    Date: 2020
  16. By: Taneli Mäkinen (Bank of Italy); Fan Li (Duke University); Andrea Mercatanti (Bank of Italy); Andrea Silvestrini (Bank of Italy)
    Abstract: The causal effect of the European Central Bank's corporate bond purchase program on bond spreads in the primary market is evaluated, making use of a novel regression discontinuity design. The results indicate that the program did not, on average, permanently alter the yield spreads of eligible bonds relative to those of noneligible. Combined with evidence from previous studies, this finding suggests the effects of central bank asset purchase programs are in no way limited to the prices of the specific assets acquired.
    Keywords: asset purchase programs, corporate bonds, causal inference
    JEL: C21 G18
    Date: 2020–11
  17. By: Mirza, Harun; Moccero, Diego; Palligkinis, Spyros; Pancaro, Cosimo
    Abstract: The assets under management of investment funds have soared in recent years, triggering a debate on their possible implications for financial stability. We contribute to this debate assessing the asset price impact of fire sales in a novel partial equilibrium model of euro area funds and banks calibrated over the period between 2008 and 2017. An initial shock to yields causes funds to sell assets to address investor redemptions, while both banks and funds sell assets to keep their leverage constant. These fire sales generate second-round price effects. We find that the potential losses due to the price impact of fire sales have decreased over time for the system. The contribution of funds to this impact is lower than that of banks. However, funds’ relative contribution has risen due to their increased assets under management and banks’ lower leverage and rebalancing towards loans. Should this trend continue, funds will become an increasingly important source of systemic risk. JEL Classification: G1, G21, G23
    Keywords: banks, financial contagion, financial stability, fire sales, investment funds, second-round price effects
    Date: 2020–11

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