Euro Area Economies Research Articles

The north-south divide, the euro and the world

The European north–south divide has been an issue of a long-standing debate. We employ a Global VAR model for 28 developed and developing countries to examine the interaction between the global trade imbalances and their impact within the euro-area framework. The aim is to assess the propagation mechanisms of real shocks, focusing on the interconnections among the north euro area and the south euro area. We incorporate theory-based long-run over-identifying restrictions and examine the effects of (i) non-export real output shocks, (ii) expansionary shocks and (iii) real exchange rate shocks. An expansionary policy of the north euro area and increased competitiveness in the south euro area could alleviate trade imbalances of the debtor euro area economies. From the south euro area perspective, internal devaluation decreases output but at the same time, it also reduces current account deficits. North euro area origin shocks to domestic output exert a dominant influence in the rest of the Europe and Asia.

Expansionary or restrictive policies in the Eurozone? Dominating trends in the first two decades

Abstract Our aim is to identify periods of restrictive versus expansionary economic policy in the euro area in the last two decades. We firstly conducted the study for identifying the dominant trend in fiscal policies and then in monetary policies. We studied several fiscal outputs, focusing on the cyclical adjusted primary balance. We also analysed the European long-term and short-term interest rates. The study was conducted for several windows, namely for 3-, 4- and 5-year periods. Additional procedures were conducted for robustness checks, namely the study of structural breaks in the analysed time series as well as a study of them recurring to Markov-Switching Regimes models. For most of the analysed periods and subperiods of the series, we concluded for the presence of expansionary policies either in the fiscal or in monetary European domains. Finally, the results and the analysis of dependencies in the euro area economy favour the evidence that economic authorities in the euro area have sought to coordinate monetary and fiscal policy to stabilise the economy.

Heterogeneity in Euro Area Monetary Policy Transmission: Results from a Large Multicountry BVAR Model

AbstractWe study cross‐country differences in monetary policy transmission across the largest euro area economies (France, Germany, Italy, and Spain) using a large Bayesian vector autoregressive (BVAR) model with endogenous prior selection. Drawing on the posterior distributions of the cross‐country differences in impulse responses and on other tests, we find real output and the money supply to respond more strongly in Germany to monetary policy than in the other countries. Whereas, the price level response is strongest in Spain and weakest in Germany. Longer‐term interest rates react more strongly in Germany and France than in Italy and Spain.

The Impact of Seven Macroprudential Policy Instruments on Financial Stability in Six Euro Area Economies

Abstract The aim of this paper is to investigate whether macroprudential policy instruments can influence the credit growth rate and hence financial stability. We use a fixed effects panel regression model to test the following hypothesis for six euro area economies (Austria, Finland, Germany, Italy, Netherlands and Spain) during time span 2010 Q3 to 2018 Q4: “Macroprudential policy instruments (degree of maturity mismatch; interbank loans as a percentage of total loans; leverage ratio; non-deposit funding as a percentage of total funding; loan-to-value ratio; loan-to-deposit ratio; solvency ratio) enhance financial stability, as measured by credit growth”. Our empirical results suggest that the degree of maturity mismatch, non-deposit funding as a percentage of total funding, loan-to-value ratio and loan-to-deposit ratio exhibit the predicted impact on the credit growth rate and therefore on financial stability. On the other hand, interbank loans as a percentage of total loans, leverage ratio, and solvency ratio do not exhibit the expected impact on the response variable. Since only four regressors (out of seven) have the signs predicted by our hypothesis, we can only partly confirm it.

Heterogeneous consumers in the Euro-Area, facing homogeneous monetary policy: Tale of two large economies

This study examines consumer behavior in the Euro-Area in response to monetary policy changes. Selecting two major Euro-Area economies, we apply factor model to investigate how German and French consumers update their macroeconomic expectations. Results at both aggregate and disaggregated levels show asymmetries in consumer responses to different monetary policy stances. We find sizable differences in the way German consumers adjust their expectations compared to the French consumers. While we record inconsistencies across different consumer expectations, we also find behavioral differences in the consumer from similar groups across both countries. The paper concludes that though consumers update their expectations immediately to a monetary policy change, French consumers show a relative discomfort and lesser confidence in the post-recession period despite accommodative moves by the European Central Bank (ECB).

Downward interest rate rigidity

Empirical evidence suggests that bank lending rates are downward rigid: banks tend to adjust their rates more slowly and less completely to short-term market rates decreases than to increases. We investigate the macroeconomic consequences of this downward interest rate rigidity by introducing asymmetric bank lending rate adjustment costs in a macrofinance dynamic stochastic general equilibrium model. Calibrating the model to the euro area economy, we find that the difference in the initial response of GDP to positive and negative economic shocks of similar amplitude can reach up to 25%. This means that a central bank would have to cut its policy rate much more to obtain a symmetric medium-run impact on GDP. We also show that downward interest rate rigidity is stronger when policy rates are stuck at their effective lower bound, further disrupting monetary policy transmission. These findings imply that neglecting asymmetry in retail interest rate adjustments may yield misguided monetary policy decisions.

Asymmetric effects of uncertainty shocks: Normal times and financial disruptions are different

We examine whether the response of the euro area economy to uncertainty shocks depends on financial conditions. We find strong evidence that uncertainty shocks have much more powerful effects on key macroeconomic variables in episodes marked by financial distress than in normal times. We also document that the recovery of economic activity following an adverse uncertainty shock is state dependent: it is gradual in normal times, but displays a more accelerated rebound when the shock hits during financial distress, reflecting monetary accommodation provided by the central bank. These findings are based on a non-linear data-driven model that accounts for regime switching and time-varying volatility. Our findings imply that whether financial markets are calm or distressed matters when it comes to the appropriate policy responses to uncertainty shocks.

Non‐Price Competitiveness Factors—A simple measure and implications for the five largest euro area countries

AbstractThis paper obtains a versatile measure of non‐price competitiveness factors (NPCF) based on a simple international trade model. Trade frictions are reinterpreted as the NPCF conditions (inferior product quality, suboptimal geographical and industry specialisation of exports and any other limitations of the production and exporting channels) that inhibit trade. The set‐up is applied to the five largest euro area economies for the period 2000–2018. Over this period, NPCF have improved significantly in the Netherlands and Spain, mildly in Italy and Germany and mildly worsened in France. In all countries, the improvement in NPCF has been more intense and sustained in the first half of the period and more unstable in the second half. The set‐up is also applied at the product level, considering four types of products depending on the stage of processing, rendering results which are similar across product types and aligned with those for the whole economy. The results suggest that the conventional North–South divide in the euro area might not be entirely applicable regarding NPCF.

Exploring Differences in Household Debt across the United States and Euro Area Countries

AbstractHousehold debt has played a central role in the global financial crisis, yet our understanding of it remains limited. We put U.S. household leverage in an international perspective, using household‐level data for the United States and 10 euro area economies. U.S. households have the highest prevalence of mortgage and consumer debt, hold comparatively large amounts and face higher debt burdens despite having higher income. We find that the U.S. economic environment is associated with a higher propensity to hold debt, primarily because a given level of collateral is associated with higher prevalence and larger amounts of mortgage debt in the United States.

Does one (Unconventional) Size Fit All? Effects of the ECB's Unconventional Monetary Policies on the Euro Area Economies

This paper aims at assessing the macroeconomic impact of unconventional monetary policies (UMPs) that the ECB has put in place in the euro area after the 2007 financial crisis. With this purpose, we first document how the relative importance of the main transmission channels of such measures has changed over time, with the portfolio rebalancing being generally more impactful than the signaling channel after the “Whatever it takes” speech in July 2012. However, we also provide evidence of a great degree of heterogeneity across core and peripheral economies, as well as over time. We then adopt a time-varying SVAR with stochastic volatility to account for such heterogeneity, by identifying UMP shocks via “dynamic” sign restrictions. By means of counterfactual experiments, we provide evidence of how a different stance on the part of the ECB would have led to a significantly different economic performance of euro area economies. For instance, if the ECB had not put in place the measures adopted between 2014 and 2017, annual output growth would have been, on average, 0.67 percentage points lower in peripheral countries.

Tracking Global Economic Uncertainty: Implications for the Euro Area

This paper sheds light on the impact of global macroeconomic uncertainty on the euro area economy. We build on the methodology proposed by Jurado et al. (2015) and estimate global as well as country-specific measures of economic uncertainty for fifteen key euro area trade partners and the euro area. Our measures display a clear counter-cyclical pattern and line up well to a wide range of historical events generally associated with heightened uncertainty. In addition, following Pier and Podstawski (2018), we estimate a Proxy SVAR where we instrument uncertainty shocks with changes in the price of gold around specific past events. We find that, historically, global uncertainty shocks have been important drivers of fluctuations in euro area economic activity, with one standard deviation increase in the identified uncertainty shock subtracting around 0.15 percentage points from euro area industrial produc-tion on impact.

Nowcasting Euro Area GDP with News Sentiment: A Tale of Two Crises

This paper shows that newspaper articles contain timely economic signals that can materially improve nowcasts of real GDP growth for the euro area. Our text data is drawn from fifteen popular European newspapers, that collectively represent the four largest Euro area economies, and are machine translated into English. Daily sentiment metrics are created from these news articles and we assess their value for nowcasting. By comparing to competitive and rigorous benchmarks, we find that newspaper text is helpful in nowcasting GDP growth especially in the first half of the quarter when other lower-frequency soft indicators are not available. The choice of the sentiment measure matters when tracking economic shocks such as the Great Recession and the Great Lockdown. Non-linear machine learning models can help capture extreme movements in growth, but require sufficient training data in order to be effective so become more useful later in our sample. JEL Classification: C43, C45, C55, C82, E37

Downward Interest Rate Rigidity

Empirical evidence suggests that bank lending rates are downward rigid: banks tend to adjust their rates more slowly and less completely to short-term market rates decreases than to increases. We investigate the macroeconomic consequences of this downward interest rate rigidity by introducing asymmetric bank lending rate adjustment costs in a macrofinance dynamic stochastic general equilibrium model. Calibrating the model to the euro area economy, we find that the difference in the initial response of GDP to positive and negative economic shocks of similar amplitude can reach up to 25%. This means that a central bank would have to cut its policy rate much more to obtain a symmetric medium-run impact on GDP. We also show that downward interest rate rigidity is stronger when policy rates are stuck at their effective lower bound, further disrupting monetary policy transmission. These findings imply that neglecting asymmetry in retail interest rate adjustments may yield misguided monetary policy decisions.

Assessing the double materiality of climate risks in the EU economy and banking sector

Financial supervisors and policy makers, including the Network for Greening the Financial System (NGFS), have recognized the existence of a feedback between climate change and the financial system, i.e. the impact of climate risks on financial stability, and the impact of financial institutions on climate scenarios. This feedback loop is known as the double materiality of climate While recent studies contributed to understand the macro-financial relevance of climate scenarios, a methodological framework to assess the materiality of climate risks is not available yet. We contribute to fill this gap by developing a dynamic climate assessment of NGFS climate physical and transition risks scenarios, for of the euro area economy and banking sector. By tailoring the EIRIN Stock-Flow Consistent model, we quantitatively assess the feedback from banks’ expectations about investment risk across NGFS scenarios and risk internalization (i.e. their climate sentiments), on (i) firms’ capital costs and performance, (ii) the decarbonization of the economy and banks’ lending portfolios, and (iii) the realization of climate mitigation scenarios. We find that, under the model conditions, an orderly transition achieves important co-benefits already in the mid-term, with respect to CO2 emissions abatement, banks’ financial stability and distributive effects. In contrast, a disorderly transition fosters banks’ financial instability. This, in turn, leads to indirect, spillover effects to the economy, affecting firms’ ability to invest in the low-carbon transition, fostering the realization of stranded assets, and increasing households’ inequality. Second, investors’ climate sentiments can affect climate policy effectiveness. Banks’ early adjustment of the cost of capital to reflect firms’ exposure to climate risks leads to alternative transition pathways, costs and co-benefits. Our results highlight the importance for financial supervisors to consider the role of investors’ expectations in the finance-economy-climate feedback, in order to design appropriate macroprudential policies for tackling climate risks.

The Impact of the Euro on Trade: Two Decades into Monetary Union

The consensus back in 2008 – ten years after the introduction of the euro – was that the adoption of a common currency had made a limited impact of around 2% in total on the trade flows of the first wave of euro area countries (Baldwin et al., 2008). Since then, six more countries have joined the euro area, and firms have internationalised their production processes. These two phenomena are interrelated and may have changed the way the common currency affects the euro area economy. Therefore, with the common currency now into its third decade – and with more countries queuing to adopt it – this paper revisits the trade effects of the euro, focusing on the newer euro adopters (i.e. those countries that have adopted the euro since 2007) and their interaction with the first wave of euro area members via supply chains. The contribution of the paper is twofold. First, it revisits the estimated aggregate impact of the euro on euro area trade, as well as on trade within and between the two waves of adopters. Data on bilateral flows between 1990 and 2015 for an extended sample of countries to estimate a gravity equation indicate a significant trade impact, ranging between 4.3% and 6.3% in total on average, with the magnitude being the highest for exports from the second wave of adopters to the first wave of adopters. If a synthetic control approach (Abadie and Gardeazabal, 2003; Abadie et al., 2010) is used instead, the estimated gains associated with euro adoption are greater. In particular, exports of both intermediate and final products from countries belonging to the first wave of euro adopters to those belonging to the second wave are estimated to have increased by about 30% using this approach. The second contribution made by this paper relates to the channels through which trade might be affected by a currency union. This question is explored by looking separately at trade in intermediate goods and final products. While we find that trade gains were mainly driven by trade in intermediate goods among countries that adopted the currency earlier (5.3%), our results also show that the euro had a positive effect on the exports of final products from the second wave of adopters to other euro area countries. This effect is as high as 10.6% with the gravity model and 32% with the synthetic control approach. One of the reasons for the difference in the range of estimates between the two approaches might be that the gravity model can control for unobserved characteristics via fixed effects, while the synthetic control approach may fail to do so. These results suggest that the euro facilitated the establishment and expansion of international production chains in Europe. In turn, this is likely to have increased business cycle synchronisation in the euro area and to have supported market access for later adopters. JEL Classification: F14, F15

Non-Bank Financial Intermediation in the Euro Area: Implications for Monetary Policy Transmission and Key Vulnerabilities

The financing structure of the euro area economy has evolved since the global financial crisis with non-bank financial intermediation taking a more prominent role. This shift affects the transmission of monetary policy. Compared with banks, non-bank financial intermediaries are more responsive to monetary policy measures that influence longer-term interest rates, such as asset purchases. The increasing role of debt securities in the financing structure of firms also leads to a stronger transmission of long-rate shocks. At the same time, short-term policy rates remain an effective tool to steer economic outcomes in the euro area, which is still highly reliant on bank loans. Amid a low interest rate environment, the growth of market-based finance has been accompanied by increased credit, liquidity and duration risk in the non-bank sector. Interconnections in the financial system can amplify contagion and impair the smooth transmission of monetary policy in periods of market distress. The growing importance of non-bank financial intermediaries has implications for the functioning of financial market segments relevant for monetary policy transmission, in particular the money markets and the bond markets.

Regional Economic Impact of COVID-19: The Role of Sectoral Structure and Trade Linkages

The paper provides an ex-post analysis of the determinants of within-country regional heterogeneity of the labour market impact of COVID-19. By focussing on the first wave of the pandemic in the four largest euro area economies, it finds that the propagation of the economic impact across regions cannot be explained by the spread of infections only. Instead, a region’s economic structure is a significant driver of the observed heterogeneity. Moreover, our results suggest that a region's trade relations, both within and across countries, represent a relevant indirect channel through which COVID-19 related disruptions affect regional economic activity. In this regard, the analysis depicts vulnerabilities arising from potential disruptions of the highly integrated EU supply chains.

Global Models for a Global Pandemic: The Impact of COVID-19 on Small Euro Area Economies

This paper analyses the effects of the COVID-19 pandemic shock on small open economies in a monetary union with an application to the euro area. Accounting for a high degree of openness and a strong dependence on intra and extra union trade, we focus on the size and the direction of international spillovers - both from the shock itself and from the ensuing fiscal response. To do so, we use a unified modelling framework: The Euro Area and the Global Economy (EAGLE) model. Furthermore, within this general framework, we assess the extent to which specific modelling features shape the dynamic responses to the COVID-19 pandemic. The main messages are as follows. First, fiscal spillovers from the rest of the monetary union do matter. Second, the effective lower bound amplifies the size of the spillovers. Third, the design of wage negotiations leads to wage subsidies having negative international fiscal policy spillovers. Fourth, import content of government spending interacts with the effective lower bound, strongly affecting the size and sign of spillovers. Fifth, when households have finite lifetimes, the responses of output and inflation are amplified compared to the case with infinitely lived households. Finally, a next generation EU instrument is more effective when financed using a tax on consumption.

Fiscal Limits and the Pricing of Eurobonds

This paper proposes a methodology to price bonds jointly issued by a group of countries—called Eurobonds in the euro-area context. We consider two types of bonds: the first is backed by several and joint (SJG) guarantees, the second features several but not joint (SNJG) guarantees. A crucial ingredient of the underlying pricing model is the fiscal limit, defined as the level of debt beyond which the risk of default is no longer zero. The pricing of the two types of Eurobonds reflects different assumptions regarding the pooling of the countries' fiscal resources and limits. We estimate fiscal limits for the four largest euro-area economies over 2008-2020 and deduce counterfactual Eurobond prices. Amid the euro-debt crisis, 5-year SNJG bond yield spreads would have been about twice larger than SJG ones. Hence, issuing SJG bonds would result in gains at the aggregate level. We finally show that (i) these gains can be shared among countries through post-issuance schemes so that all countries benefit from the issuance of SJG bonds, and that (ii) these redistribution schemes may alleviate the reduction in market discipline resulting from common bond issuances.

Euro Area Policies

The COVID-19 pandemic has led to severe socio-economic dislocations and hardship. Supported by an unprecedented policy response and by the easing of lockdown measures as the infection rate moderated, the euro area economy initially recovered strongly from the pandemic’s first wave. However, a large second wave and reimposition of containment measures suggest much slower growth momentum in the near term. The outlook is for a subdued economic recovery and low inflation, with a significant permanent output loss relative to the pre-crisis trajectory. Uncertainty remains extremely high, mainly due to different pandemic scenarios, including regarding the availability and effectiveness of potential vaccines and therapies and behavioral changes. Output growth is expected to be much lower through 2021Q1 than projected in 2020 October World Economic Outlook (WEO) but may rebound beyond then in light of recent promising news on vaccine development. The key policy challenge is to continue countering the pandemic while facilitating a robust and inclusive recovery, including by addressing the health crisis, containing economic scarring, supporting resource reallocation and transformation to greener and more digital economies, and limiting the crisis’s impact on inequality and poverty. In a downside scenario, sizable further stimulus would be needed.