nep-eec New Economics Papers
on European Economics
Issue of 2021‒02‒01
fourteen papers chosen by
Giuseppe Marotta
Università degli Studi di Modena e Reggio Emilia

  1. The macroeconomic impact of the Next Generation EU instrument on the euro area By Bańkowski, Krzysztof; Ferdinandusse, Marien; Hauptmeier, Sebastian; Jacquinot, Pascal; Valenta, Vilém
  2. EMU deepening and sovereign debt spreads: using political space to achieve policy space By Iván Kataryniuk; Víctor Mora-Bajén; Javier J. Pérez
  3. A Prolonged Period of Low Interest Rates: Unintended Consequences By Simona Malovana; Josef Bajzik; Dominika Ehrenbergerova; Jan Janku
  4. The implications of liquidity regulation for monetary policy implementation and the central bank balance sheet size: an empirical analysis of the euro area By Kedan, Danielle; Veghazy, Alexia Ventula
  5. The effect on foreign direct investment of membership in the European Union By Bruno, Randolph Luca; Ferreira Campos, Nauro; Estrin, Saul
  6. Measuring the cost of equity of euro area banks By Altavilla, Carlo; Bochmann, Paul; De Ryck, Jeroen; Dumitru, Ana-Maria; Grodzicki, Maciej; Kick, Heinrich; Fernandes, Cecilia Melo; Mosthaf, Jonas; O’Donnell, Charles; Palligkinis, Spyros
  7. Breaking Badly: The Currency Union Effect on Trade By Douglas L. Campbell; Aleksandr Chentsov
  8. The Exchange Rate Insulation Puzzle By Corsetti, G.; Kuester, K.; Müller, G. J.; Schmidt, S.
  9. Demographic change and the German current account surplus By Schön, Matthias
  10. How Loose, How Tight? A Measure of Monetary and Fiscal Stance for the Euro Area By Nicoletta Batini; Alessandro Cantelmo; Giovanni Melina; Stefania Villa
  11. A European Minimum Wage: Implications for Poverty and Macroeconomic Imbalances By Enrica Detragiache; Christian H Ebeke; La-Bhus Fah Jirasavetakul; Koralai Kirabaeva; Davide Malacrino; Florian Misch; Hyun Woo Park; Yu Shi
  12. The impact of Climate on Economic and Financial Cycles: A Markov-switching Panel Approach By Monica Billio; Roberto Casarin; Enrica De Cian; Malcolm Mistry; Anthony Osuntuyi
  13. The Ideological Use and Abuse of Freiburg's Ordoliberalism By Malte Dold; Tim Krieger
  14. The Fall in German Unemployment: A Flow Analysis By Carlos Carrillo-Tudela; Andrey Launov; Jean-Marc Robin

  1. By: Bańkowski, Krzysztof; Ferdinandusse, Marien; Hauptmeier, Sebastian; Jacquinot, Pascal; Valenta, Vilém
    Abstract: In response to the economic fallout from the coronavirus (COVID-19) pandemic, the European Council agreed on the Next Generation EU (NGEU) instrument. NGEU allows the European Commission to issue debt to finance grants and loans to EU Member States, with the disbursement of funds intended to be weighted towards the countries most affected by the crisis. This paper assesses the macroeconomic impact on the euro area of different uses of NGEU, using a large dynamic stochastic general equilibrium (DSGE) model of the euro area and global economy (EAGLE) that has been adapted to reflect the modalities of the NGEU instrument. Three uses of NGEU loans and grants are explored: (i) productive public investment, (ii) unproductive government spending, and (iii) replacing or repaying existing sovereign debt. The EAGLE results are cross-checked with a semi-structural model (ECB-BASE) and with the basic model elasticities (BMEs) of the forecasting models in use in the national central banks of the Eurosystem. JEL Classification: C54, E62, E65, F54, F47
    Keywords: COVID-19, EMU, euro area, NextGenerationEU, public investment
    Date: 2021–01
  2. By: Iván Kataryniuk (Banco de España); Víctor Mora-Bajén (Banco de España); Javier J. Pérez (Banco de España)
    Abstract: Sovereign spreads within the European Monetary Union (EMU) arise because markets price-in heterogeneous country fundamentals, but also re-denomination risks, given the incomplete nature of EMU. This creates a permanent risk of financial fragmentation within the area. In this paper we claim that political decisions that signal commitment to safeguarding the adequate functioning of the euro area influence investors’ valuations. We focus on decisions conducive to enhancing the institutional framework of the euro area (“EMU deepening”). To test our hypothesis we build a comprehensive narrative of events (decisions) from all documents and press releases issued by the Council of the EU and the European Council during the period January 2010 to March 2020. We categorize the events as dealing with: (i) economic and financial integration; (ii) fiscal policy; (iii) bailouts. With our extremely rich narrative at hand, we conduct event-study regressions with daily data to assess the impact of events on sovereign bond yields and find that indeed decisions on financial integration drive down periphery spreads. Moreover, while decisions on key subjects present a robust effect, this is not the case with prior discussions on those subjects at the Council level. Finally, we show that the impacts arise from reductions in peripheral sovereign spreads, and not by the opposite movement in core countries. We conclude that EU policy-makers have at their disposal signicant “political space” to reduce fragmentation and gain “policy space”.
    Keywords: Euro area, EU integration, sovereign spreads, financial fragmentation
    JEL: E44 F36 G14
    Date: 2021–01
  3. By: Simona Malovana; Josef Bajzik; Dominika Ehrenbergerova; Jan Janku
    Abstract: We examine the potential adverse effects of a prolonged period of low interest rates on financial stability from multiple perspectives. First, we provide a unique comparison of natural rates of interest estimated using two approaches - with and without financial factors - for six large European countries inside and outside the euro area. The results indicate that the need for monetary policy easing or tightening may differ across economies and over time. Financial factors and macro-financial linkages further amplify these differences, implying that business and financial cycles may not be well synchronized across countries, with the financial cycle being more desynchronized. We then provide a comprehensive review of the empirical literature, allowing us to identify and categorize financial vulnerabilities which may be created and fueled by low interest rates. We discuss a situation in which a prolonged period of low interest rates may lead to a point of no return by contributing to higher indebtedness, overvalued asset prices and underpriced risks, resource and credit misallocation, and lower productivity. With respect to all of that, we offer a few monetary policy considerations, including a short discussion of the role of macroprudential policy. Specifically, we suggest that (i) monetary policy should act symmetrically over the medium to long term, (ii) both the short-term and long-term costs and benefits of pursuing accommodative or restrictive monetary policy should be accounted for, and (iii) monetary and macroprudential policies need to be coordinated, and their interactions should be accounted for in order to find the best policy mix for the economy.
    Keywords: Financial stability, financial vulnerabilities, low interest rates, monetary policy, natural rate of interest
    JEL: E52 E58 G2
    Date: 2020–12
  4. By: Kedan, Danielle; Veghazy, Alexia Ventula
    Abstract: We analyse the impact of the Liquidity Coverage Ratio (LCR) on the demand for central bank reserves in the euro area with difference-in-differences estimation techniques. Using a novel dataset and an identification strategy that exploits the cross-country heterogeneity in the regulatory treatment of reserves for LCR purposes prior to the announcement of a harmonised euro area standard as a quasi-natural experiment, we find evidence that points to LCR-induced demand for reserves. Specifically, our results suggest that banks with low LCRs relative to peers increased their central bank reserve holdings as a result of the LCR regulation. Our findings have economically meaningful implications for the operational framework of monetary policy and imply that the Eurosystem’s balance sheet may need to remain larger than it was prior to the financial crisis and the associated introduction of new liquidity regulation. JEL Classification: C23, E52, G28
    Keywords: Basel III, central bank operational framework, ECB, liquidity coverage ratio, monetary policy
    Date: 2021–01
  5. By: Bruno, Randolph Luca; Ferreira Campos, Nauro; Estrin, Saul
    Abstract: This paper explores the impact of EU membership on foreign direct investment (FDI). It analyses empirically how the effects of such deep integration differ from other forms and investigates what drives these effects. Using a structural gravity framework on annual bilateral FDI data for almost every country in the world, over 1985-2018, we find EU membership leads FDI into the host economy to be about 60% higher for investment from outside the EU, and around 50% higher for intra-EU FDI. Moreover, we find that the effect of EU membership on FDI is larger than from membership of NAFTA, EFTA, or MERCOSUR, and that the Single Market is the cornerstone of this differential impact.
    Keywords: deep economic integration; Foreign direct investment; European Union; structural gravity model; single market; forthcoming
    JEL: F3 G3
    Date: 2021–01–06
  6. By: Altavilla, Carlo; Bochmann, Paul; De Ryck, Jeroen; Dumitru, Ana-Maria; Grodzicki, Maciej; Kick, Heinrich; Fernandes, Cecilia Melo; Mosthaf, Jonas; O’Donnell, Charles; Palligkinis, Spyros
    Abstract: The cost of equity for banks equates to the compensation that market participants demand for investing in and holding banks’ equity, and has important implications for the transmission of monetary policy and for financial stability. Notwithstanding its importance, the cost of equity is unobservable and therefore needs to be estimated. This occasional paper provides estimates of the cost of equity for listed and unlisted euro area banks using a three-step methodology. In the first step, ten different models are estimated. In the second step, the models’ results are combined applying an equal-weighting procedure. In the third step, the combined costs of equity for individual banks are aggregated at the euro area level and according to banks’ business models. The results suggest that, since the Great Financial Crisis of 2007-08, the premia that investors demand to compensate them for the risk they bear when financing banks’ equity has been persistently higher than the return on equity (ROE) generated by banks. We show that our estimates of cost of equity have plausible relationships to banks’ fundamentals. The cost of equity tends to be higher for banks that are riskier (higher non-performing loan ratios), less efficient (higher cost-to-income ratio), and with more unstable funding sources (higher relative reliance on interbank deposits). Finally, we use bank fundamentals to estimate the cost of equity for unlisted banks. In general, unlisted banks are found to have a somewhat lower cost of equity compared to listed banks, with business model characteristics accounting for part of the estimated difference. JEL Classification: G20, G21, E44, G1
    Keywords: banking supervision, cost of equity, financial stability, monetary policy
    Date: 2021–01
  7. By: Douglas L. Campbell (New Economic School); Aleksandr Chentsov (New Economic School)
    Abstract: As several European countries debate entering, or exiting, the euro, a key policy question is how much currency unions (CUs) affect trade. Despite the longstanding academic debate on the topic, even recent research has continued to find that CUs exert a large effect on trade. We find, by contrast, that the sizeable recent estimated impact of CUs on trade is driven by other major geopolitical events and is also sensitive to dynamic controls. Overall, we estimate that the impact of CUs on trade is typically indistinct from zero, depending on the specification and controls, but with fairly large standard errors.
    Keywords: Euro, Currency Union Effect, Gravity Estimation
    JEL: F15 F33 F54
    Date: 2021–01
  8. By: Corsetti, G.; Kuester, K.; Müller, G. J.; Schmidt, S.
    Abstract: The notion that flexible exchange rates insulate a country from foreign shocks is well grounded in theory, from the classics (Meade, 1951; Friedman 1953), to the more recent open economy literature (Obstfeld and Rogoff, 2000). We confront it with new evidence from Europe. Specifically, we study how shocks that originate in the euro area spill over to its neighboring countries. We exploit the variation of the exchange rate regime across time and countries to assess whether the regime alters the spillovers: it does not - flexible exchange rates fail to provide insulation against euro area shocks. This result is robust across a number of specifications and holds up once we control for global financial conditions. We show that the workhorse open-economy model can account for the lack of insulation under a float, assuming that central banks respond to headline consumer price inflation. However, it remains puzzling that policy makers are ready to forego stabilization of economic activity to the extent we found in the data.
    Keywords: External shock, International spillovers, Exchange rate, Insulation, Monetary Policy, Dominant currency pricing, Effective lower bound
    JEL: F41 F42 E31
    Date: 2021–01–21
  9. By: Schön, Matthias
    Abstract: This paper shows that demographic change plays an important role in the formation of a country's net foreign asset position. An ageing population both lowers the demand and increases the supply of capital in an economy. Fewer workers reduce the required capital stock. As a longer life span leads to a longer retirement phase individuals save more. Simultaneously, necessary adjustments of pay-as-you-go pension systems to an ageing society affect aggregate savings. Taking Germany as an example, this paper applies a two-region model with endogenous savings and labour supply that is augmented with demographic data projections for OECD countries. It shows that demographic change in Germany is an important determinant of the current account. Counterfactual pension reform simulations show that a fixed pension level increases the current account while a fixed pension contribution rate lowers it. An increase in the retirement age results in a strong negative effect on the current account as it reduces the capital supply and increases the capital demand in an economy.
    Keywords: Demographic Change,Current Account,Pension System
    JEL: E27 E62 F21 H55 J11
    Date: 2020
  10. By: Nicoletta Batini; Alessandro Cantelmo; Giovanni Melina; Stefania Villa
    Abstract: This paper builds a model-based dynamic monetary and fiscal conditions index (DMFCI) and uses it to examine the evolution of the joint stance of monetary and fiscal policies in the euro area (EA) and in its three largest member countries over the period 2007-2018. The index is based on the relative impacts of monetary and fiscal policy on demand using actual and simulated data from rich estimated models featuring also financial intermediaries and long-term government debt. The analysis highlights a short-lived fiscal expansion in the aftermath of the Global Financial Crisis, followed by a quick tightening, with monetary policy left to be the “only game in town” after 2013. Individual countries’ DMFCIs show that national policy stances did not always mirror the evolution of the aggregate stance at the EA level, due to heterogeneity in the fiscal stance.
    Keywords: Fiscal policy;Fiscal stance;Expenditure;Dynamic stochastic general equilibrium models;Financial crises;WP
    Date: 2020–06–05
  11. By: Enrica Detragiache; Christian H Ebeke; La-Bhus Fah Jirasavetakul; Koralai Kirabaeva; Davide Malacrino; Florian Misch; Hyun Woo Park; Yu Shi
    Abstract: A hypothetical European Minimum Wage (MW) set at 60 percent of each country’s median wage would reduce in-work poverty but have limited effects on overall poverty, as many poor households do not earn a wage near MW and higher unemployment, higher prices, and a loss of social insurance benefits may erode direct benefits. Turning to competitiveness, since the MW increase to reach the European standard would be larger in euro area countries with excessive external surpluses, the associated real appreciation should help curb existing imbalances. However, a few countries with already weak external positions would experience an undesirable real appreciation.
    Keywords: Wages;Minimum wages;Poverty;Labor costs;Wage adjustments;WP,wage-inflation pass-through,wage growth,MW harmonization,wage competitiveness,wage differentiation
    Date: 2020–05–22
  12. By: Monica Billio; Roberto Casarin; Enrica De Cian; Malcolm Mistry; Anthony Osuntuyi
    Abstract: This paper examines the impact of climate shocks on 13 European economies analysing jointly business and financial cycles, in different phases and disentangling the effects for different sector channels. A Bayesian Panel Markov-switching framework is proposed to jointly estimate the impact of extreme weather events on the economies as well as the interaction between business and financial cycles. Results from the empirical analysis suggest that extreme weather events impact asymmetrically across the different phases of the economy and heterogeneously across the EU countries. Moreover, we highlight how the manufacturing output, a component of the industrial production index, constitutes the main channel through which climate shocks impact the EU economies.
    Date: 2020–12
  13. By: Malte Dold; Tim Krieger
    Abstract: In the aftermath of the Eurozone crisis, a battle of ideas emerged over whether ordoliberalism is part of the cause or the solution of economic problems in Europe. While German ordoliberals argued that their policy proposals were largely ignored before, during and after the crisis, critics saw too much ordoliberal influence, especially in form of austerity policies. We argue that neither view is entirely correct. Instead, we observe that the battle of ideas is largely independent of the countries’ actual responses to the Eurozone crisis: pragmatic self-interest on behalf of governments rather than their ideological convictions played a crucial role in political reactions. We explain this dynamic game-theoretically and highlight a number of reasons for the decoupling of the political-pragmatic debate from the ideological-academic discourse. In addition, we argue that ordoliberals themselves contributed to the ideological misuse of their own program: the ordoliberal Freiburg School ceased to be an active research program and instead grew to resemble a tradition which all too often disregarded the international academic discourse, in particular in macroeconomics. As a result, ordoliberal thinking was abused by its proponents and critics alike to emphasize their preconceived Weltanschauung (worldview).We end our paper with some thoughts on how a contemporary ordoliberalism can be constructively used to react to some of the challenges of the ongoing Eurozone crisis.
    Keywords: Freiburg School, ordoliberalism, Eurozone crisis, austerity, ideology
    JEL: B29 D43 E61 G18 P16
    Date: 2020
  14. By: Carlos Carrillo-Tudela; Andrey Launov; Jean-Marc Robin
    Abstract: In this paper we investigate the recent fall in unemployment, and the rise in part-time work and labour market participation amongst prime-aged Germans. We show that unemployment fell because the Hartz reforms induced a large fraction of the long-term unemployed to deregister as jobseekers. However, labour force participation actually increased because many female non-participants accepted low-paid, part-time jobs. Counterfactual simulations using estimated transition probabilities show that observed changes in the stocks of registered and unregistered unemployment as well as marginal, contributed part-time and full-time employment after 2002 essentially resulted from changes in registered and unregistered unemployment outflows. Yet to obtain the full decrease in registered male unemployment, we need to account for the effect of wage moderation. A calibrated Diamond-Mortensen-Pissarides model suggests that wage moderation is at most half as strong as the unemployment reforms in explaining changes in unemployment, non-participation and part-time employment.
    Keywords: unemployment, part-time work, mini-jobs, non-participation, wage moderation, Hartz reforms
    JEL: J21 J31 J63 J64
    Date: 2020

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