nep-eec New Economics Papers
on European Economics
Issue of 2021‒07‒26
twelve papers chosen by
Giuseppe Marotta
Università degli Studi di Modena e Reggio Emilia

  1. Incentive compatible relationship between the ERM II and close cooperation in the Banking Union: the cases of Bulgaria and Croatia By María J. Nieto; Dalvinder Singh
  2. Do Fundamentals Explain Differences between Euro Area Sovereign Interest Rates? By Stéphanie Pamies; Nicolas Carnot; Anda Pătărău
  3. Confidence and economic activity in Europe By Saccal, Alessandro
  4. Bail-in and Bank Funding Costs By Vittoria Cerasi; Paola Galfrascoli
  5. State-Dependent Effects of Tax Changes in Germany and the United Kingdom By Bernd Hayo; Sascha Mierzwa
  6. Emotions in Macroeconomic News and their Impact on the European Bond Market By Sergio Consoli; Luca Tiozzo Pezzoli; Elisa Tosetti
  7. Capital ratios and banking crises in the European Union By Raphaël Cardot-Martin; Fabien Labondance; Catherine Refait-Alexandre
  8. Migration and Labor Market Integration in Europe By Dorn, David; Zweimüller, Josef
  9. Inside the black box: tools for understanding cash circulation By Luca Baldo; Elisa Bonifacio; Marco Brandi; Michelina Lo Russo; Gianluca Maddaloni; Andrea Nobili; Giorgia Rocco; Gabriele Sene; Massimo Valentini
  10. The eurozone: what is to be done? By Minford, Patrick; Ou, Zhirong; Wickens, Michael; Zhu, Zheyi
  11. Sectoral shocks and monetary policy in the United Kingdom By Dixon, Huw; Franklin, Jeremy; Millard, Stephen
  12. Who Should Bear the Burden of Covid-19 Related Fiscal Pressure? An Optimal Income Taxation Perspective By Mehmet Ayaz; Lea Fricke; Clemens Fuest; Dominik Sachs

  1. By: María J. Nieto (Banco de España); Dalvinder Singh (University of Warwick)
    Abstract: The goal of expanding participation in the European Banking Union was to allow the “outs” to enter into close cooperation, but it did not include the simultaneous joining of the Exchange Rate Mechanism (ERM II). Focusing on the cases of Bulgaria and Croatia, this paper attempts to respond to various questions. What is the rationale behind the double requirement of having simultaneously to apply to become a member of the ERM II and to prepare to become a member of the Banking Union via the rule-based “close-cooperation” coordination mechanism between the EU non-euro-area national competent authorities (NCAs) and the European Central Bank (ECB)? Does the integration of close-cooperation countries’ banking systems with the euro-area banking systems support the decision to join the ERM II and “opting in” to the Single Supervisory Mechanism (SSM)? What are the advantages of preparing to become a full member of the euro area and the SSM? It is evident from the research undertaken in this paper that there are clear benefits of close cooperation for these member states whose domestic currencies are already linked to the euro, in view of the dominant position eurozone banks have in their respective domestic markets. It is more difficult for a national central bank or NCA to exercise discretion in implementing ECB decisions once it is committed to the path leading to full European Monetary Union (EMU) membership. Hence the commitment to join the EMU minimises the authority risk for the ECB as well as for the Single Resolution Board, as safeguards become non-significant and termination is not an issue. The uncertainty about the functioning and durability of the close-cooperation arrangement is largely removed.
    Keywords: Banking Union, close cooperation, ERM II
    JEL: E02 E44 F15 G15 G21 H12 K23
    Date: 2021–07
  2. By: Stéphanie Pamies; Nicolas Carnot; Anda Pătărău
    Abstract: This paper explores the determinants of sovereign interest rate spreads of euro area countries (vis-à-vis Germany), using panel regressions with annual data for 2000-2019. It focuses on the role of fundamental factors, namely fiscal, macroeconomic and institutional variables, while considering also some contextual factors such as global risk aversion and controlling for the influence of central banks’ asset purchases. Through extensive testing of various (fiscal) variables, interactions and non-linearities, the analysis confirms that sovereign spreads respond to fundamental variables, especially the government debt, indicating that such response is non-linear. The results also show that structural factors, such as potential growth and the quality of institutions, can largely mitigate the impact from government debt on spreads. Indeed, in countries with the highest potential growth and strongest institutions, the marginal effect of government debt on spreads would be close to zero. From a policy angle, the results are a reminder that, even in an environment of persistently low rates, more solid fundamentals allow governments to benefit from lower borrowing costs and lessrisk exposure. They also highlight that policies aimed at reinforcing potential growth and government effectiveness can be expected to improve investors’ perception of sovereign risk and their forbearance of higher debt.
    JEL: H63 E43 E62 C23 O52
    Date: 2021–06
  3. By: Saccal, Alessandro
    Abstract: This work supplies additional empirical evidence of responses in real economic activity to shocks in confidence. A structural vector autoregression (SVAR) featuring confidence, real consumption and real output is constructed with respect to the Euro area and eight European nations. Results are mixed: responses exhibit reversibility and irreversibility, suggesting the formulation of a theoretical mechanism capable of formalising such a variety. The potential causes behind confidence in the same nations are moreover evaluated through a panel data regression. Results indicate aversion towards output, inflation, unemployment, monetary independence and financial openness, but favour population, exchange rate rigidity and the accumulation of sovereign debt.
    Keywords: confidence; economic activity; Europe.
    JEL: C32 C33 E37
    Date: 2021–07–17
  4. By: Vittoria Cerasi; Paola Galfrascoli
    Abstract: We empirically evaluate the impact of the new resolution policy, the so-called Bank Recovery and Resolution Directive (BRRD) enacted in 2016, on the cost of funding for EU banks. We first measure the change in the spreads of credit default swaps on subordinated and senior bonds issued by EU banks around the period when the policy became effective and provide evidence of a greater increase in the risk premia of more junior bail-in-able bonds than for senior bonds. We then investigate the reasons for the different intensities by which this policy has affected the banks in our sample. We uncover specific characteristics of banks and macroeconomic factors to explain this heterogeneity. Banks with more problematic loans, that are less capitalized, and that are headquartered in countries with a higher risk premium on sovereign debt have experienced a greater rise in the cost of their funds; conversely, larger banks with a greater proportion of domestic over total subsidiaries were less affected. Moreover, we show that the low-interest-rate environment has increased the riskiness of all the banks in our sample. Overall, our paper provides evidence that market discipline has been reinforced by the adoption of the BRRD.
    Keywords: Bank resolution; Credit Default Swaps; Market discipline.
    JEL: G28 G21 G14
    Date: 2021–07
  5. By: Bernd Hayo (University of Marburg); Sascha Mierzwa (University of Marburg)
    Abstract: We study state-dependent effects of narratively identified tax shocks in Germany and the UK over the period 1974Q1–2018Q4 using local projections. In addition, we distinguish between aggregated and disaggregated tax types (direct and indirect taxes) as well as look for possible asymmetries between tax hikes and tax cuts. We find a number of differences across the business cycle, and between sample countries, tax types, and direction of tax changes. For instance, aggregated tax cuts initially have a larger effect during times of nonrecession in Germany, whereas we find no state-dependent effects for the UK. When disaggregating tax types, German indirect tax cuts only appear expansionary during downturns, whereas the effect is positive throughout the business cycle in the UK. Furthermore, we find different reactions when considering tax cuts and hikes individually: tax hikes can be expansionary in Germany (UK) when implemented during non-recessionary (recessionary) periods whereas they are contractionary during recessions (non-recessions). When considering tax cuts, German GDP rises only when cuts are enacted in times of non-recession, whereas in the UK, the reactions is positive in either case and mostly symmetric. All these findings are robust to various changes in the econometric setup.
    Keywords: Fiscal policy, tax policy, legislated tax changes, state dependence, direct taxes, indirect taxes, asymmetric effects, Germany, United Kingdom, local projections, narrative approach
    JEL: E62 E63 H20 H30 K34
    Date: 2021
  6. By: Sergio Consoli; Luca Tiozzo Pezzoli; Elisa Tosetti
    Abstract: We show how emotions extracted from macroeconomic news can be used to explain and forecast future behaviour of sovereign bond yield spreads in Italy and Spain. We use a big, open-source, database known as Global Database of Events, Language and Tone to construct emotion indicators of bond market affective states. We find that negative emotions extracted from news improve the forecasting power of government yield spread models during distressed periods even after controlling for the number of negative words present in the text. In addition, stronger negative emotions, such as panic, reveal useful information for predicting changes in spread at the short-term horizon, while milder emotions, such as distress, are useful at longer time horizons. Emotions generated by the Italian political turmoil propagate to the Spanish news affecting this neighbourhood market.
    Date: 2021–06
  7. By: Raphaël Cardot-Martin (CRESE EA3190, Univ. Bourgogne Franche-Comté, F-25000 Besançon, France); Fabien Labondance (CRESE EA3190, Univ. Bourgogne Franche-Comté, F-25000 Besançon, France); Catherine Refait-Alexandre (CRESE EA3190, Univ. Bourgogne Franche-Comté, F-25000 Besançon, France)
    Abstract: We assess if capital ratios reduced the occurrence of banking crises in the European Union from 1998 to 2017. We use a Probit model and estimate the effect of two measures: the bank capital to total assets ratio and the bank regulatory capital to Risk Weighted Assets (RWA). We found that both measures affect negatively the probability of crisis. This result is robust to the exclusion of outliers, to the inclusion of various control variables for banking, financial and macroeconomic risks. Finally, we show that while the bank regulatory capital to RWA has always a negative effect on the probability of crisis, the bank capital to total assets ratio is only significant above a threshold, estimated between 10% and 12%.
    Keywords: Unconventional measures, retail interest rate, Heterogeneous panel
    JEL: G21 E44
    Date: 2021–07
  8. By: Dorn, David (University of Zurich); Zweimüller, Josef (University of Zurich)
    Abstract: The European labor market allows for the border-free mobility of workers across 31 countries that cover most of the continent's population. However, rates of migration across European countries remain considerably lower than interstate migration in the United States, and spatial variation in terms of unemployment or income levels is larger. We document patterns of migration in Europe, which include a sizable migration from east to west in the last twenty years. An analysis of worker-level microdata provides some evidence for an international convergence in wage rates, and for modest static gains from migration. We conclude by discussing obstacles to migration that reduce the potential for further labor market integration in Europe.
    Keywords: labor migration, wages, Europe, European Union single market
    JEL: F22 F53 J31 J61
    Date: 2021–07
  9. By: Luca Baldo (Bank of Italy); Elisa Bonifacio (Bank of Italy); Marco Brandi (Bank of Italy); Michelina Lo Russo (Bank of Italy); Gianluca Maddaloni (Bank of Italy); Andrea Nobili (Bank of Italy); Giorgia Rocco (Bank of Italy); Gabriele Sene (Bank of Italy); Massimo Valentini (Bank of Italy)
    Abstract: In this study, we assess the main drivers of banknote circulation in Italy over the last decades by using a number of econometric tools proposed in the literature. We explore the role played by the banknote flows from abroad, changes in the institutional framework and disentangle domestic demand for transaction purposes from other components, including liquidity hoarding. We find that changes in legal limits on cash payment and money holdings for precautionary reasons explain the bulk of cash dynamics. Moreover, the share of transaction demand declined over time becoming of second-order. Finally, we find that, during the pandemic from Covid-19, the exceptional raise in cash circulation was mostly the result of an increase in precautionary demand due to both economic uncertainty and restrictions to mobility that resulted into a marked decline of lodgments to the central bank.
    Keywords: cash circulation, cash, payment habits, Covid-19 pandemic
    JEL: E41 E42 G2
    Date: 2021–07
  10. By: Minford, Patrick (Cardiff Business School); Ou, Zhirong (Cardiff Business School); Wickens, Michael (Cardiff Business School); Zhu, Zheyi (Cardiff Business School)
    Abstract: We construct a macro DSGE model of the eurozone and its two main regions, the North and the South, with the aim of matching the macro facts of these economies by indirect inference and using the resulting empirically-based model to assess possible new policy regimes. The model we have found to fit the facts suggests that substantial gains in macro stability and consumer welfare are possible if the fiscal authority in each region is given the freedom to respond to its own economic situation. Further gains could come with the restoration of monetary independence to the two regions, in effect creating a second 'southern euro' bloc.
    Keywords: eurozone; macro stability; fiscal policy; monetary independence
    JEL: E32 E52 E62 F41
    Date: 2021–06
  11. By: Dixon, Huw (Cardiff Business School); Franklin, Jeremy (Bank of England); Millard, Stephen (Bank of England, Centre for Macroeconomics and Durham University Business School.)
    Abstract: In this paper, we examine the extent to which monetary policy should respond to movements in sectoral inflation rates. To do this we construct a Generalised Taylor model that takes specific account of the sectoral make-up of the consumer price index (CPI). We calibrate the model for each sector using the UK CPI microdata. We find that a policy rule that allows for different responses to inflation in different sectors outperforms a rule which just targets aggregate CPI, as does a rule that responds only to non food and energy inflation. However, we find that the optimal sectoral rule only leads to a small absolute improvement in terms of extra consumption.
    Keywords: CPI inflation, Sectoral inflation rates, Generalised Taylor economy, Financial Intermediation
    JEL: E17 E31 E52
    Date: 2021–05
  12. By: Mehmet Ayaz; Lea Fricke; Clemens Fuest; Dominik Sachs
    Abstract: The Covid-19 pandemic has led to an increase in public debt in most countries. This will increase fiscal pressure in the future. We study how the shape of the optimal nonlinear income tax schedule is affected by this increase in fiscal pressure. We calibrate the workhorse optimal income tax model to five European countries: France, Germany, Italy, Spain and the UK. We apply the inverse-optimum approach to the pre-Covid-19 economies. We then ask how the schedule of marginal and average tax rates should be optimally adjusted to the increase in fiscal pressure. For all countries, we find that the increase in fiscal pressure leads to a less progressive optimal tax schedule both in terms of marginal and average tax rates.
    Keywords: Fiscal pressure, optimal taxation
    JEL: H21 H23
    Date: 2021

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