EMU Countries Research Articles

Lending effects of the ECB’s asset purchases

Between 2010 and 2012, the European Central Bank absorbed €218 billion worth of government securities from five EMU countries under the Securities Markets Programme (SMP). Detailed security holdings data at the bank level affirms an effective lending stimulus due to the SMP. Exposed banks contract household lending, but increase commercial lending substantially. Holding non-SMP securities from stressed EMU countries amplifies the commercial lending response. The SMP also improved liquidity buffers and profitability without compromising credit quality.

The euro's effect on trade: an analysis of "old" and "new" EMU members

This paper provides new empirical evidence of the ``euro effect" on bilateral trade by allowing for a heterogeneous impact on ``new" and ``old" EMU members. By applying a Poisson estimator and focusing on a sample of 38 countries, our results show a positive but statistically insignificant euro’s effect on bilateral exports. However, disaggregating this effect, we report a relatively large euro’s effect on bilateral trade for the “new” EMU countries. We also find no evidence of trade diversion, thus corroborating existing evidence. These results are robust to a number of sensitivity checks and, especially, to the use of a larger sample of countries. Finally, using country-pair and country-industry-pair data, our results indicate a reduction in export concentration in the bilateral trade of ``old" EMU countries. Instead, we find an increase in concentration in trade between ``new" and ``old" EMU countries.

Inequality in EMU: is there a core periphery dualism?

Income inequality has had a minor role in the European integration process’ institutional framework. This is unfitting given that reducing disparities has been one of the most explicit goals of EU, which has consequently devoted an increasing share of its budget to regional policy. This issue has potentially relevant policy implications because if the European integration has a role in increasing inequalities within member countries it is harmful for social cohesion. This paper intends to assess inequality determinants in EMU countries and whether the European integration process has been itself among them. It performs an empirical investigation on a panel of 12 EMU member States in the period 1980-2015. The contribution of this paper to the literature is twofold: first, it focuses on the effects of European integration on inequality in EMU countries over the last 25 years, on which the evidence is still scarce. Second, it tries to disentangle the European integration impact on inequality in core and periphery EMU countries. The empirical evidence suggests that the effects of the European integration process, captured by trade and financial openness indicators, on income inequality was heterogeneous across country groups. Once disentangling the country sample in core and periphery groups, as identified by the relevant literature, estimate results seem to support the hypothesis of a core periphery dualism also for what concerns income inequality trends within the EMU.

Examining the Effects of the European Monetary Union Using Propensity Score Matching

We examine the treatment effects of joining the European monetary union on macroeconomic outcomes in the member countries. Specifically, we apply propensity score analysis to mitigate the self-selection bias associated with the non-random nature of joining the union. The findings suggest joining the union leads to decline in inflation, inflation volatility, real GDP growth and bond yield for the post-EMU formation period. The treatment effects on bond yield and debt show divergent pattern in core and periphery countries after the financial crisis. The bond market in the southern EMU countries benefited disproportionately in the pre-crisis period in terms of lower bond yields.

Effects of monetary policy shocks on income mobility in the Euro area countries

This paper examines the impacts of monetary policy shocks on income mobility in the Euro area, relying on earnings heterogeneity and income composition channels through which monetary policy affects income distribution. From a relative mobility perspective, upward and downward mobility are estimated over the period 2004-2014 for the EMU countries that originated the Economic and Monetary Union (EMU 1999). By using a vector error correction model (VECM) approach, overall we find that an expansionary monetary policy seems to encourage upward mobility and discourage downward mobility. By income groups, a loose monetary policy appears to reduce downward mobility for the upper class, while no empirical evidence can be provided to support that monetary policy shocks alter upward mobility for the lower class. Monetary policy shocks are especially favourable for the middle class as an expansionary monetary policy seems to boost upward mobility. A detailed analysis of the middle class shows that an expansionary monetary policy may propel the upward mobility and hinder the downward mobility of the lower-middle class, particularly favouring this income group.

Sovereign Bond Yield Spreads Spillovers in the EMU

We study the sovereign bond market co-movements and spillovers within 10 EMU countries, the so-called “periphery” and “core” countries, during the period 1999:01 to 2016:07. Implementing Generalized Methods of Moments (GMM) within a panel setting and bivariate VAR analysis, we find that an increase in the lagged spreads of Italian and Austrian bonds negatively affect the spreads of the whole sample while the increase in the Irish, Portuguese, Belgian and French lagged yields increased the overall spreads. In the VAR analysis we find that spillover effects within the sample are mostly positive.

Spillover effects of credit default risk in the euro area and the effects on the Euro: A GVAR approach

AbstractDuring the 2008 financial crisis, increasing risk and spillovers became a main concern for policy makers and banks. In addition, changes in sovereign and bank risk are believed to have had strong effects on world‐wide exchange rates. This paper aims to analyse these dynamics empirically. We estimate a Global VAR (GVAR) model for nine EMU countries plus Japan, the United Kingdom, and the United States and identify structural risk shocks using sign restrictions. Our results indicate that spillover effects of general risk are much stronger than those of bailouts. Furthermore, we demonstrate that the Euro depreciates significantly against the Yen and U.S. dollar following general risk shocks in the euro area and only to a small extent following bailout shocks. The Pound Sterling is not affected by any of these shocks. The Euro variability is, from the EMU perspective, mainly driven by shocks stemming from large countries (e.g., Germany, France, and Italy). However, shocks from third countries also play an important role.

Twin deficits and fiscal spillovers in the EMU's periphery. A Keynesian perspective

The objective of this paper is to shed light on the twin deficit hypothesis in Southern Europe and the MENA region, taking into account fiscal spillovers from the core during the global crisis. Using Godley and Lavoie (2007)'s baseline model, we first show that fiscal shocks from a core region could aggravate macroeconomic imbalances in the periphery. We then gather data from the period 1977–2016 for ten MENA and peripheral EMU countries, and model the twin deficit hypothesis in the presence of fiscal spillover with a P-VARX methodology. Our results highlight that fiscal balance, current account, and GDP growth rates in the EMU's periphery are negatively affected by fiscal consolidations in the core. Fiscal discipline in surplus countries is tantamount to a ‘beggar thy neighbor’ effect on the periphery, in times of crisis. We discuss the implications of our results to propose further international coordination of macroeconomic policies.

Credit prices vs. credit quantities as predictors of economic activity in Europe: Which tell a better story?

This paper examines the role of external credit providers in the EMU and assesses the effects of credit spreads and credit quantities on economic activity. Movements in credit spreads are far more successful than movements in the external finance mix in predicting near-term changes in real economic activity in ten EMU countries. However, the forecasting performance of the three credit spreads evaluated in this paper is uneven. A risk premium extracted from individual corporate bond yields predicts economic activity fairly well in Germany and Southern Europe. Two other credit spreads, the ‘spread’ and the ‘ECB-spread’, have predictive power for some measures of economic activity but they fail to predict consistently across either a range of economic indicators or countries.

German Wage Moderation and European Imbalances: Feeding the Global VAR with Theory

AbstractGerman labor market reforms in the 1990s and 2000s are generally believed to have driven the large increase in the dispersion of current account balances in the Euro Area. We investigate this hypothesis quantitatively. We develop a three‐region open economy New Keynesian model with search and matching frictions from which we derive robust sign restrictions for wage bargaining and matching efficiency shocks which we term wage moderation shocks. We impose these restrictions on a Global VAR consisting of Germany and eight EMU countries to identify a wage moderation shock in Germany. Our results show that, although the German current account was significantly affected by wage moderation shocks, their contribution to European current account imbalances was negligible. We conclude that the German labor market reforms cannot be the lone driver of European imbalances.

Dynamics of net foreign asset components in the EMU

In the last two decades, foreign capital investments have followed different paths in EMU countries. Given their importance for growth and productivity, we analyse the factors underlying the dynamics of foreign direct investments, portfolio debt investments, and portfolio equity investments in EMU countries over the years 1996–2014. We assess how the heterogeneous behaviour between core and peripheral countries can be related to macroeconomic factors (business cycle, trade, financial openness and spreads) and institutional quality. Our results show that financial integration as well as interest rates spread had an impact on the main components of foreign assets which was different between core and peripheral countries. In EMU countries as a whole we find a statistical significant relationship between institutional quality and foreign capital components, which is entirely driven by core countries.

Sovereign default, exit and contagion in a monetary union

The euro area sovereign debt crisis is characterized by a simultaneous surge in the cost of borrowing for peripheral EMU countries following the Greek debt-trouble in 2008. We develop a model with optimal default and monetary-union exit decisions of a small open economy. Our model can account for the behavior of sovereign bond spreads in the eurozone with the arrival of the news of Greece potentially exiting the euro in the near future. In our theoretical framework, belonging to the monetary-union entails a strong exchange rate peg, which can be abandoned only if the country exits the union. Exit is costly and the cost of exit remains unknown until the first country leaves the union. The theoretical mechanism we explore reveals that while a high expected exit-cost could improve the credibility of a monetary union, uncertainty governing exit-cost realizations could make the monetary-union members prone to surges in interest rates when rumors of a member state exiting arise. We solve the model numerically and quantify that a Grexit-rumors type of shock can triple the default likelihood of an a-priori financially healthy member state. Our framework thus provides a novel and quantitatively important explanation for the eurozone crisis.

Revisiting the bi-directional causality between debt and growth: Evidence from linear and nonlinear tests

We revisit the bi-directional causality between public debt and the rate of GDP growth for 10 EMU countries alongside the US, UK and Japan, over sample periods spanning from 1970 up to 2014 whilst accounting for the nonlinear properties of both the individual time series, and their relation in both directions. Our results indicate that the causal relation between debt and growth, in either direction, is weak at best. For most of the countries in our sample, we find no robust evidence of a long-run causal effect using bi-variate Granger causality tests. Bi-directional causality is detected only for Austria, while for France, Luxembourg and Portugal, causality runs solely from debt to growth, but the estimated effects are very small. In Finland, Spain and Italy, Granger causality (from growth to debt in the former two and debt to growth in Italy) appears to be present in the short-run. Our findings cannot be taken as evidence that a high level of public indebtedness is not risky for the economy or as invalidating hypotheses postulating effects in either direction in the relation between debt and growth.

EMU and the Size of the Public Sector

The purpose of this paper is to examine whether membership in the EMU increases the size of the public sector. The estimation of the effect of the EMU on the ratio of government outlays to GDP is based on synthetic counterfactuals. It is found that the average size of the public sector in the EMU countries is higher than what it would have been without the monetary unification. The estimated effects are particularly strong in countries that have had the most unstable governments and the highest level of political competition in the eurozone. These findings support the hypothesis that political distortions of short-sighted governments that produce excessive deficits already under monetary autonomy may be worsened by accession to the monetary union.

Making the Eurozone Works: A Risk-Sharing Reform of the European Stability Mechanism

This work presents an original proposal for the reform of the Eurozone architecture according to an approach based on risk sharing (aiming to reach in the long-term the mutualization of public debt). The proposal envisages a new role for the European Stability Mechanism (ESM) which should gradually become the guarantor of the public debts of the EMU. In this way, the new ESM would support the full transition from national debts to a single Eurozone public debt (e.g. Eurobonds) with a single yield curve for all countries. Our proposal would benefit both core and peripheral EMU countries. Indeed, the riskiest countries, which would gain from the ESM conditional debt guarantee, should give up the possibility of redenominating their national debt and would pay to the ESM the corresponding market price of the guarantee. This would strengthen the capital endowment of the ESM and also allow it to use its leverage capability to support the realignment of the economic cycles of the different countries through profitable public investment plans concentrated in the weakest regions of the EMU. Such plans would be coordinated and implemented by the European Union. After a transition period, our Insurance Fund proposal would contribute to a much more resilient monetary union, with a European fiscal policy and debt. Admittedly this proposal presupposes a political consensus at the EU level to reinterpret to the no bailout rule enshrined in the treaties so that risk sharing institutions implemented with fairly priced insurance scheme can be allowed. New risk sharing institutions will foster a common vision of belonging to the same federal, political union in the making, the only one compatible with the abdication of fiscal sovereignty by national governments.

The state dependent impact of bank exposure on sovereign risk

Abstract The theoretical literature remains inconclusive on whether changes in bank exposure to the domestic sovereign have an adverse effect on the sovereign risk position through a diabolic loop in the sovereign-bank nexus, or reduce perceived default risk by acting as a disciplinary device for the sovereign. In this paper we empirically analyze the impact of exogenous changes in bank exposure on the risk position of the sovereign within a Markov switching structural vector autoregressive in heteroscedasticity (MSH-SVAR) framework for a set of EMU countries. We add to the methodological literature by allowing for regime dependent shock transmissions according to the volatility state of the financial system. Finding support for both, a stabilizing and a destabilizing effect, we document a clear clustering among the country sample: rising bank exposure increased default risk for the EMU periphery, but decreased credit risk for the core EMU countries during times of financial stress.

The State Dependent Impact of Bank Exposure on Sovereign Risk

The theoretical literature remains inconclusive on whether changes in bank exposure towards the domestic sovereign have an adverse effect on the sovereign risk position via a diabolic loop in the sovereign-bank nexus or reduce perceived default risk by acting as a disciplinary device for the sovereign. In this paper we empirically analyze the impact of exogenous changes in bank exposure on the risk position of the sovereign within a Markov switching structural vector autoregressive in heteroscedasticity (MSH-SVAR) framework for a set of EMU countries. We add to the methodological literature by allowing for regime dependent shock transmissions according to the volatility state of the financial system. Finding support for both, a stabilizing and a destabilizing effect, we document a clear clustering among the country sample: Rising bank exposure increased default risk for the EMU periphery, but decreased credit risk for the core EMU countries during times of financial stress.

Price-Level Convergence in the Eurozone: A Brief History of Convergence and Divergence

This paper shows that price level trends in many of the EMU countries evolve with different patterns and that these patterns will not converge in the long-run. We propose that the hypothesis of price convergence should be evaluated and tested employing the relative prices. To this aim, we: (i) define the asymptotic price level convergence in mean and variance, (ii) provide a model for relative price levels that includes a transition path, and (iii) show how to properly test the definitions stated. Our results show that only French and German price levels converge in mean to a zero gap in the EMU while some others, not many, converge to a non-zero significant gap. This should be a matter of concern for the European monetary policy makers as it implies that the monetary policy does not affect all the EMU members equally.

External Stress Early Warning Indicators

We examine the determinants of external stress episodes through probit analysis, focusing on the role of foreign liabilities in order to build an external crisis early warning indicator for a set of selected EMU countries. We use a panel country data spanning 1970-2011 from External Wealth Dataset (Phillip Lane). Our results show that the ratio of net and gross foreign liabilities to GDP and current account balances — which measure external debt accumulation speed — are significant stress predictors, although (net) FDI liabilities seem an offset factor. Early warning indicators are based on a signalling approach and exploit panel dimension of the data to develop a country specific indicator. We find that EMU peripheral countries’ external indebtedness remains higher than risk threshold, in spite of the external adjustment accumulated in the last years in some countries. This result highlights the necessity of going on structural reforms that reinforce competitiveness of these economies.

Fiscal sustainability in EMU countries: A continued fiscal commitment?

The aim of this paper is to study the sustainability of public finances in the Eurozone particularly after the 2007 financial crisis. This paper goes beyond the standard analysis of the univariate properties of the fiscal variables through the estimation of a time-varying fiscal reaction function on a 11-country panel for a period spanning from 1970 to 2014. Even if panel unit root or stationary tests may provide a rough first insight on the sustainability of the public finances, they fail to highlight the adjustment mechanisms to debt overhang in recent years. The main advantage of our empirical approach is that it clearly captures the government’s dynamic response to debt accumulation, which signals its commitment to readjust public debt towards a sustainable path. Time-varying estimates of the fiscal reaction function shed new light on this respect and reveal certain heterogeneity among EMU countries on the way they manage their public finances. This paper helps ascertain whether the public resources destined to bail out troubled countries triggered effective fiscal responses.