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on European Economics |
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Issue of 2023‒12‒11
twenty papers chosen by Giuseppe Marotta, Università degli Studi di Modena e Reggio Emilia |
| By: | Rojas, Luis E.; Thaler, Dominik |
| Abstract: | The feedback loop between sovereign and financial sector insolvency has been identified as a key driver of the European debt crisis and has motivated an array of policy proposals. We revisit this “doom loop” focusing on governments’ incentives to default. To this end, we present a simple 3-period model with strategic sovereign default, where debt is held by domestic banks and foreign investors. The government maximizes domestic welfare, and thus the temptation to default increases with externally-held debt. Importantly, the costs of default arise endogenously from the damage that default causes to domestic banks’ balance sheets. Domestically-held debt thus serves as a commitment device for the government. We show that two prominent policy prescriptions – lower exposure of banks to domestic sovereign debt or a commitment not to bailout banks – can backfire, since default incentives depend not only on the quantity of debt, but also on who holds it. Conversely, allowing banks to buy additional sovereign debt in times of sovereign distress can avert the doom loop. In an extension we show that in the context of a monetary union (such as the euro area) similar unintended negative consequences may arise from the pooling of debt (such as European safe bond aka. ESBies). A backstop by the central bank (such as the ECB’s Transmission Protection Instrument) can successfully disable the loop if precisely calibrated. JEL Classification: E44, E6, F34 |
| Keywords: | bailout, doom loop, ESBies, self-fulfilling crises, sovereign default, transmission protection instrument |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20232869&r=eec |
| By: | Nektarios A. Michail (Central Bank of Cyprus); Kyriaki G. LouKa (Central Bank of Cyprus) |
| Abstract: | We examine whether quantitative easing had an impact on output and inflation in the euro area. Using a BVAR model, over the March 2015 - December 2021 period, our results suggest that quantitative easing is an inefficient policy tool. In particular, following a shock that increases asset purchases by around 1% of euro area GDP, inflation increases by around 0.01%, while industrial production rises by 0.3%. The biggest beneficiary of quantitative easing is the stock market, rising more than 2% after the shock. Since only a very small share of the general populace holds stocks, this has adverse inequality effects. |
| Keywords: | quantitative easing; euro area; inequality; asset purchases |
| JEL: | E58 E52 C32 |
| Date: | 2023–10 |
| URL: | http://d.repec.org/n?u=RePEc:cyb:wpaper:2023-3&r=eec |
| By: | Martín Fuentes, Natalia; Born, Alexandra; Bremus, Franziska; Kastelein, Wieger; Lambert, Claudia |
| Abstract: | This paper investigates the contribution of capital markets to international risk sharing in the euro area over the 2000Q1-2021Q1 period. It provides three main contributions: First, the estimation of country-specific vector autoregressions (VAR) shows that shock absorption through capital markets remains modest, particularly in the southern euro area. Second, we analyse the geographical patterns of the capital channel. While risk sharing between southern and northern euro area countries led the improvements in income smoothing at the beginning of the 2000s, intra-regional capital flows supported income smoothing in the recent past. Third, based on a panel threshold VAR, we analyse how the composition of external capital positions impacts the capital channel. Long-term portfolio debt assets and liabilities as well as equity liabilities significantly improved income smoothing. The effect is more pronounced for northern countries, in line with their larger cross-border portfolios, when compared to the southern countries. Regarding foreign direct investment, only northern countries benefited from inward positions. JEL Classification: C23, E62, G11, G15 |
| Keywords: | capital channel, CMU, external financial structure, international risk sharing, panel threshold vector autoregression (TVAR) model |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20232864&r=eec |
| By: | Bekaert, Geert; Hoerova, Marie; Xu, Nancy R. |
| Abstract: | We study how monetary policy and risk shocks affect asset prices in the US, the euro area, and Japan, differentiating between “traditional” monetary policy and communication events, each decomposed into “pure” and information shocks. Communication shocks from the US spill over to risk in the euro area and vice versa, but traditional US shocks show no spillover effects to risk. Both monetary policy and communication shocks spill over to stocks, with euro area information spillovers being particularly strong. US spillovers are consistent with global CAPM intuition whereas euro area spillovers are larger. Importantly, we document a strong global component of risk shocks which is not driven by monetary policy. JEL Classification: E44, E52, G12, G20, E32 |
| Keywords: | central bank communications, global financial cycle, interest rate, international spillovers, monetary policy, risk, stock returns, trilemma |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20232879&r=eec |
| By: | Allaire, Nolwenn; Breckenfelder, Johannes; Hoerova, Marie |
| Abstract: | Using security-by-security data on investor holdings in the euro area, we study run dynamics across different fund-shares of the same fund during the unprecedented liquidity crisis in March 2020. For an average bond or equity mutual fund-share, households, other euro area funds, and the foreign sector each represent about a quarter of the total holdings. Insurance companies hold another 14%, with all other investors combined (banks, non-financial corporations, pension funds, etc.) accounting for less than 10% of holdings. Analyzing bond funds, we show that fund-shares with higher ownership by other funds suffered substantially higher outflows (by 6 percentage points), while fund-shares with higher ownership by households had substantially lower outflows (by 5 percentage points) compared to the other fund-shares within the same fund. This gap is not driven by time-varying differences in fund performance. Results for equity funds are similar, although they faced substantially smaller outflows, coupled with much larger declines in performance, compared to bond funds. Our findings suggest that a collective “dash for cash” by consumers and firms in need of liquidity at the outset of the COVID-19 pandemic was not the source of mutual fund fragility. Instead, the most run-prone investor type turned out to be the fund sector itself. JEL Classification: G01, G10, G21, G23 |
| Keywords: | investor type, liquidity, March 2020 liquidity crisis, mutual funds, runs |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20232874&r=eec |
| By: | Kyriaki G. LouKa (Central Bank of Cyprus); Nektarios A. Michail (Central Bank of Cyprus) |
| Abstract: | We examine the transmission of monetary policy to bank interest rates in the euro area, using rolling 10-year samples. The results suggest that the pass through of policy rates to bank interest rates was relatively stable prior to the use of unconventional monetary policy measures, in which case the multiplier increased, especially for housing and short-term NFCs loans. It appears that Quantitative Easing (QE) operations allow for bank lending rates to further decline, however, this could lead to higher lending in those particular loan categories, with certain repercussions to the economy. In addition to the excess liquidity created by asset purchases, other factors such as credit risk and house price growth also appear to impact the pass through. |
| Keywords: | pass through, deposit beta, error correction, euro area, asset purchases |
| JEL: | E43 |
| Date: | 2023–08 |
| URL: | http://d.repec.org/n?u=RePEc:cyb:wpaper:2023-2&r=eec |
| By: | Mariarosaria Comunale; Anh D. M. Nguyen |
| Abstract: | This paper develops a new data-driven metric to capture MacroEconomic Uncertainty (MEU) in the euro area. The measure is constructed as the conditional volatility of the unforecastable components of a large set of time series, accounting for the monetary union as well as cross-country heterogeneity. MEU exhibits the largest spike at the time of the COVID-19 outbreak and is noticeably different from other more financial-oriented and policy-driven uncertainty measures. It also reveals a significant increase in inflation uncertainty in 2021-2022. Our BVAR-based analysis shows that an unexpected increase in the MEU has a negative and persistent impact on euro area's industrial production, accounting for 80 percent of its reduction during the first wave of COVID-19, therefore supporting the interpretation of COVID-19 shock as a macroeconomic uncertainty shock. Public debt increases in response to this uncertainty shock. Finally, an increase in MEU negatively affects Emerging Europe countries, contributing the most to the decline in their economic activity during this COVID-19 period. |
| Keywords: | macroeconomic uncertainty; euro area; Bayesian VARs; COVID-19 |
| Date: | 2023–11–03 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2023/229&r=eec |
| By: | Pallotti, Filippo; Paz-Pardo, Gonzalo; Slacalek, Jiri; Tristani, Oreste; Violante, Giovanni L. |
| Abstract: | We measure the heterogeneous welfare effects of the recent inflation surge across households in the Euro Area. A simple framework illustrating the numerous channels of the transmission mechanism of surprise inflation to household welfare guides our empirical exercise. By combining micro data and aggregate time series, we conclude that: (i) country-level average welfare costs –expressed as a share of 2021–22 income– were larger than a typical recession, and heterogeneous, e.g., 3% in France and 8% in Italy; (ii) this inflation episode resembles an age-dependent tax, with the elderly losing up to 20%, and roughly half of the 25–44 year-old winning; (iii) losses were quite uniform across consumption quantiles because rigid rents served as a hedge for the poor; (iv) nominal net positions are the key driver of heterogeneity across-households; (v) the rise in energy prices generated vast variation in individual-level inflation rates, but unconventional fiscal policies were critical in shielding the most vulnerable households. JEL Classification: D12, D14, D31, E21, E52, E58 |
| Keywords: | consumption, fiscal support, household heterogeneity, housing, inflation, labor income, net nominal positions, redistribution |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20232877&r=eec |
| By: | Bańbura, Marta; Bobeica, Elena; Martínez Hernández, Catalina |
| Abstract: | We propose a framework to identify a rich set of structural drivers of inflation in order to understand the role of the multiple and concomitant sources of the post-pandemic inflation surge. We specify a medium-sized structural Bayesian VAR on a comprehensive set of variables for the euro area economy. We analyse in particular various types of supply shocks, some of which were not considered relevant before the pandemic, notably global supply chain shocks and gas price shocks. The residuals of the VAR are assumed to admit a factor structure and the shocks are identified via zero and sign restrictions on factor loadings. The framework can deal with ragged-edge data and extreme observations. Shocks linked to global supply chains and to gas prices have exhibited a much larger influence than in the past. Overall, supply shocks can explain the bulk of the post-pandemic inflation surge, also for core inflation. Being able to gauge the impact of such shocks is useful for policy making. We show that a counterfactual core inflation measure net of energy and global supply chain shocks has been more stable after the pandemic. JEL Classification: E31, C32, C38, Q54 |
| Keywords: | Bayesian VAR, gas prices, inflation, supply chain bottlenecks, supply shocks |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20232875&r=eec |
| By: | Bouabdallah, Othman; Jacquinot, Pascal; Patella, Valeria |
| Abstract: | In most euro area countries, the monetary/fiscal policy mix is responsible for the changing history of debt and inflation facts. Using a Dynamic Stochastic General Equilibrium model with Markov-switching policy rules, we identify three distinct monetary/fiscal regimes in France and Italy: a Passive Monetary-Active Fiscal regime (PM/AF) before the late 80s/early 90s; an Active Monetary-Passive Fiscal regime (AM/PF) with central bank independence and EMU convergence; a third regime with policy rates at the effective lower bound combined with fiscal active behavior to sustain the recovery. Our simulations reveal that the PM/AF regime in France led to price volatility and debt stabilisation, while the AM/PF regime resulted in disinflation and rising debt trajectory. Meanwhile, Italy’s procyclical fiscal policy in downturns contributed to persisting imbalances, high aggregate volatility, and low growth. JEL Classification: E63, E62, E32, E52, C32 |
| Keywords: | debt, euro area, inflation, Markov-switching, Monetary-fiscal policy mix |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20232871&r=eec |
| By: | Jung, Alexander |
| Abstract: | The Federal Reserve’s (Fed) monetary policy announcements have created massive spillovers to global financial markets. Based on daily data for the sample from 1999 to 2019, this study finds that the Fed’s monetary policy announcements created significant international spillovers to bond yields and stock prices of European banks and non-financial corporations (NFCs), while changes in uncertainty around the expected Fed policy path and Fed information effects constituted critical additional dimensions of these spillover effects. International spillovers to bond yields of banks and NFCs were similar, while stock prices of European banks responded somewhat stronger than those of NFCs. The significant spillovers from the Fed’s forward guidance to European bond yields show that central bank communication is very relevant for international transmission. In relation to earlier studies emphasizing strong QE-related spillovers, this study suggests that Fed QE announcements created only small spillovers on bond yields and stock prices of European banks and NFCs. JEL Classification: E44, E52, F42, G14, G21 |
| Keywords: | high-frequency event study, instrumental variables, local projections, monetary policy shocks, monetary policy uncertainty |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20232876&r=eec |
| By: | Bochmann, Paul; Dieckelmann, Daniel; Fahr, Stephan; Ruzicka, Josef |
| Abstract: | We empirically analyze the interaction of monetary policy with financial stability and the real economy in the euro area. For this, we apply a quantile vector autoregressive model and two alternative estimation approaches: simulation and local projections. Our specifications include monetary policy surprises, real GDP, inflation, financial vulnerabilities and systemic financial stress. We disentangle conventional and unconventional monetary policy by separating interest rate surprises into two factors that move the yield curve either at the short end or at the long end. Our results show that a build-up of financial vulnerabilities tends to be accompanied initially by subdued financial stress which resurges, however, over a medium-term horizon, harming economic growth. Tighter conventional monetary policy reduces inflationary pressures but increases the risk of financial stress. [...] JEL Classification: E31, E52, G01, G10 |
| Keywords: | macroprudential policy, monetary policy, monetary policy identification, quantile regressions, financial stability |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20232870&r=eec |
| By: | Clodomiro Ferreira (Bank of Spain); Stefano Pica (Bank of Italy) |
| Abstract: | We study the joint behavior of households’ survey expectations for a wide range of macroeconomic and individual-level variables in the largest six euro area countries, both in the cross-section and time series. Although households disagree, their expectations are correlated in the cross-section. Two principal components explain a significant portion of the variance of all expectations. These components capture households’ perceptions of the sources of macroeconomic dynamics, with the first capturing supply-side views and the second component reflecting demand-side views. This structure of perceptions and disagreement is stable across countries and time and does not vary with demographic or socioeconomic characteristics. We then use these insights to identify two common factors driving expectations over time. The factors co-move strongly with measures of supply and demand disturbances and align well with a narrative based on increasing perceived inflationary pressures coming from supply after the invasion of Ukraine in February 2022. |
| Keywords: | Survey, Expectations, Inflation, Output, Supply, Demand |
| JEL: | D1 D8 E2 E3 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:aoz:wpaper:287&r=eec |
| By: | Wenxin Du; Alessandro Fontana; Petr Jakubik; Ralph S J Koijen; Hyun Song Shin |
| Abstract: | We study patterns and implications of global asset allocations of European insurers and banks using newly available supervisory data. We show that the total assets of insurance companies and pension funds (ICPF) far exceed the amount of government bonds outstanding in Europe, and that countries with a large ICPF sector tend to have a large corporate bond market. Despite high levels of international investments, the characteristics of domestic financial markets still loom large in insurers’ and banks’ portfolio allocation, with two newly documented international portfolio frictions playing a prominent role. First, when investing abroad, insurers and banks do not offset attributes of the domestic markets (such as the composition of fixed-income markets, interest rates, and sovereign credit risk), which we label “domestic projection bias.” Second, subsidiaries of multinational groups act like local entities, which we label the “going native bias.” We propose a theoretical framework to explain our empirical findings and discuss the broader policy implications for European capital market deepening and integration, monetary policy transmission and financial stability, and a multi-sectoral approach to regulatory design. |
| Keywords: | Banks, insurance companies, pension funds, portfolio choice, fixed income, home bias |
| JEL: | G2 G11 G15 G21 G22 G28 |
| Date: | 2023–10 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:1137&r=eec |
| By: | Czudaj, Robert L. |
| Abstract: | This paper proposes a new measure proxying the degree of anchoring of inflation expectations on an individual forecaster level and studies the co-movement of this measure with expectations regarding monetary policy and different cost-push factors. In doing so, we rely on data taken from the ECB Survey of Professional Forecasters for both parts of the analysis. First, we construct a measure for the degree of anchoring of inflation expectations for each forecaster based on his inflation expectations taking into account both point and density forecasts. Second, we regress this anchoring measure on the professional forecasters' expectations regarding the policy rate of the ECB and three different cost factors potentially affecting the inflation rate: the crude oil price, the USD/EUR exchange rate, and unit labor costs. The main findings indicate that expectations regarding a tightening of monetary policy are generally able to enhance the degree of anchoring while an expected increase in both the crude oil price and unit labor costs seems to lower the degree of anchoring. The latter finding is more pronounced for shorter horizons. |
| Keywords: | Anchoring, Inflation expectations, Monetary policy, Crude oil, Unit labor costs |
| JEL: | E31 E52 Q43 |
| Date: | 2023–11–02 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:119029&r=eec |
| By: | Savoia, Ettore |
| Abstract: | Using detailed micro-data, this paper documents that households with lower income risk (and higher income levels) exhibit a higher Marginal Propensity to Consume (MPC) in response to transitory income shocks, all else being equal. This finding is particularly significant among unconstrained households and supported by models with precautionary saving only if designed to account for the empirically observed negative correlation between income levels and income risk. This interaction generates saving dynamics such that the stationary distribution of wealth among households facing different risk levels is not polarized.Therefore, it is possible to compare their respective MPCs within wealth and identify the reduction in MPC due to labor income risk. Otherwise, the effects of income risk are masked by wealth effects. In neither case, the MPC depends on (permanent, persistent, or current) income levels, whose direct effect on the MPC is always ambiguous. Finally, simulations of targeted fiscal rebates for specific labor categories reveal that governments cannot simultaneously stimulate aggregate demand and mitigate income risk. JEL Classification: D12, D52, D81, E21, J31 |
| Keywords: | income risk, marginal propensity to consume, precautionary saving |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20232866&r=eec |
| By: | Yannick Bury; Lars P. Feld; Ekkehard A. Köhler |
| Abstract: | We test whether the proactive use of instruments of direct democracy by voters can help to explain fiscal sustainability of 25 Swiss cantons. Using data of all cantonal popular votes since 1977, our results show that the fiscal reaction of cantonal governments to an increase in the debt to GDP ratio of a canton is stronger, the more cantonal voters actively made use of their direct democratic rights in the previous year. |
| Keywords: | direct democracy, political process, fiscal policy |
| JEL: | H11 H50 D72 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10759&r=eec |
| By: | Engel, Janina; Ohlwerter, Dennis; Scherer, Matthias |
| Abstract: | The Household Finance and Consumption Survey (HFCS) provides valuable information for the monetary policy and financial stability purposes. The dataset shows, however, inconsistencies with National Account (NtlA) statistics, as the aggregated HFCS micro data do usually not match the corresponding NtlA macro data. Therefore, we suggest a solution to close the gap via an optimization problem that aims at preserving for each wealth instrument the level of inequality measured by the Gini coefficient. In addition, a lower and an upper bound of inequality are derived, that can be reached by extreme allocations of the wealth discrepancies across the households. Finally, based on the German HFCS, we compare the findings with another approach suggested in the literature that uses a “multivariate calibration”. The comparison indicates that the multivariate calibration may reallocate households’ wealth beyond the observed discrepancies, thereby leading to Gini coefficients that exceed the analytically derived upper bound of inequality. JEL Classification: C46, C61, D31, G51, N34 |
| Keywords: | HFCS, national accounts, optimization problem, wealth inequality |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20232865&r=eec |
| By: | Massimo Morelli; Tito Boeri; Matteo Gamalerio; Margherita Negri |
| Abstract: | We study whether a better knowledge of the functioning of pay-as-you-go pension systems and recent demographic trends affects natives’ attitudes towards immigration. In two online experiments conducted in Italy and Spain, we randomly treated participants with a video explaining how, in pay-as-you-go systems, the payment of current pensions depends on the contributions paid by current workers. The video also informs participants about population aging trends in their countries. The treatment increases knowledge of pay-as-you-go systems and future demographic trends for all participants. However, it improves attitudes towards migrants only for treated participants who do not support populist and anti-immigrant parties. Keywords: Information provision, experiment, immigration, pay-as-you-go pension systems, population aging, populism JEL:C90, D83, H55, J15, F22. |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:igi:igierp:705&r=eec |
| By: | Andreas Teichgraeber; John Van Reenen |
| Abstract: | What research and innovation (R&I) policies should Europe adopt? The world faces a challenge to rebuild after the pandemic, but also faces the same structural slowdown of productivity growth that occurred in the decades before the COVID crisis. We need to have a plan around innovation policy to address the challenge. We show that Europe is less innovative on many dimensions compared to other advanced regions, such as the US and parts of Asia. We review the econometric evidence on R&I policies and argue that there is good evidence for the efficacy of many of them. A mix of R&D subsidies, reinvigorated competition and a big push on expanding the quantity and quality of human capital is needed. These could be bound together around the need for green innovation in order to achieve the mission to radically reduce carbon emissions. |
| Keywords: | innovation, R&D, human capital, Europe |
| Date: | 2022–02–25 |
| URL: | http://d.repec.org/n?u=RePEc:cep:poidwp:025&r=eec |