Euro Area Member Countries Research Articles

NFLATION PERSISTENCE AND UNIT ROOT TESTS IN THE EURO AREA COUNTRIES

Persistence is one of the main characteristics of inflation. One of the definitions of persistent inflation is, that it is the rate at which inflation reaches equilibrium after a certain macroeconomic shock. If the inflation persistence is high, the response to inflation shocks is long-lasting and difficult for the central bank to control. Conversely, if the country’s inflation persistence is low, the central bank can keep the inflation rate in line with the inflation target. The recent economic crisis made central banks adopt several unconventional monetary policy instruments to boost economic recovery and preserve price stability. Many authors note that data on stationary inflation in the euro area countries is a precondition for joining the European Union. As far as the functioning of the European Union is concerned, it is desirable to take the necessary decisions. The primary objective of the paper is to test the inflation rate data in the euro area countries to verify the existence of a unit root considering that central banks design their monetary policy frameworks under the assumption that inflation is a stationary process. The verification of the stationarity of the inflation data is divided into two sections. In the first section, the monthly data panel of the Harmonised Index of Consumer Prices (HICP) for euro-zone countries is used. The second section uses a panel of monthly data the Harmonised Index of Consumer Prices for each category of Classification of Individual Consumption by Purpose for euro area countries. Our results indicate that time series for inflation in 11 of 19 euro area member countries are non-stationary and have a unit root. Considering our results we propose the creation of a two-speed euro area and the adjustment of the monetary policy framework in the euro area countries.

The Decline of EMU Core Countries’ Portfolio Equity Investments in the Euro Area: The Role of Stock Return Correlations

This paper investigates the effect of time-varying stock market correlations on the abrupt and persistent decrease of the reciprocal foreign investments by Euro area member countries after 2007. A strong stock market correlation reduces the diversification opportunities and it may therefore have affected the reciprocal investment by EMU countries. The 2007 represents both the outbreak of the global financial crisis and the beginning of the enlargement process. The two events have had a very different impact on the stock returns’ correlation among EMU members. While the enlargement to new countries has reduced the average returns’ correlation within the Euro area as a whole, the financial crisis and the sovereign debt crisis have led to an increase in stock returns’ correlation among old member states. We find that, among old EMU countries, core countries have been particularly affected by stock returns’ correlation. They reduced their equity investments both in foreign EMU core and in foreign EMU periphery economies after the crisis, with a particularly pronounced contraction witnessed by those country-pairs that displayed highly correlated asset returns. These results highlight the importance of the diversification motive for international portfolio investments and complement the institution-based explanation of the decline of the Euro area investments.

Hysteresis and stochastic convergence in Eurozone unemployment rates: evidence from panel unit roots with smooth breaks and asymmetric dynamics

Research background: Studying the dynamic characteristics of unemployment rate is crucial for both economic theory and macroeconomic policies. Despite numerous research, the empirical evidence about stochastic behaviour of the unemployment rate remains disputable. It has been widely agreed that most economic variables, including unemployment rates, are characterized by both structural breaks and nonlinearities. However, a little work is done to examine both features simultaneously. Purpose of the article: In this paper, we analyse the stationarity properties of unemployment rates of Euro area member countries. Also, we aim to test stochastic convergence of unemployment rates among member countries. Our empirical procedures explicitly allow for simultaneous gradual breaks and nonlinearities in the series. Methods: This paper develops a new unit root test procedure for panel data, allowing for both gradual structural breaks and asymmetric adjustment towards equilibrium. We carry out Monte Carlo simulations to examine small sample performance of the proposed test procedure and compare it to the existing test procedures. We apply the newly proposed test to examine the stochastic properties of the unemployment rates of Euro-member countries as well as relative unemployment rates vis-?-vis the Eurozone unemployment rate. Findings & value added: We find that the newly developed test procedure outperforms existing tests in highly nonlinear settings. Also, these tests reject the null hypothesis of unit root in more cases when compared to the existing tests. We find stationarity in the series only after allowing for structural breaks in the data generating process. Allowing for nonlinear and asymmetric adjustment in addition to gradual breaks provides evidence of stationarity in more cases. Furthermore, our results suggest that relative unemployment rate series are stationary, providing evidence in favour of stochastic convergence in unemployment rates. Overall, our results imply a limited room for coordinated economic policy to fight unemployment in the Eurozone.

The importance of selected structural competitiveness indicators for exports : a comparative analysis between the euro area and Greece

Structural (non-price) competitiveness departs from price or cost competitiveness and captures a multitude of dimensions, both quantitative and qualitative, affecting the trade and openness of a country. Greece over time has lagged behind in key structural competitiveness indicators relative to other euro area countries, but has improved its position in some of the indicators in the recent years, in terms of relative prices and unit labour costs. The paper examines the evolution of selected price and structural competitiveness indicators approximated with institutional quality indicators (published by international organisations), recording the performance of Greece and euro area countries over the last decade, on an annual basis, in order to gain more insight into how exports are affected. A panel regression of an export demand function is estimated for the 19 euro area member countries, separately for each of the selected indicators. It is confirmed that structural competitiveness, along with price competitiveness, has played an important role in determining exports in the euro area and in Greece over the 2007-19 period. Greater sensitivity of Greek exports to institutional quality indicators is found, compared with average euro area exports. This is an indication of the faster pace of reform implementation in other euro area countries, while the reforms in Greece are in a process of catching up. The implementation of structural reforms in the direction of improving institutional deficiencies has contributed, among other factors, to the observed post-crisis export-led growth in Greece. In conclusion, the pace of reforms already under way should be accelerated and this will be mirrored in the structural competitiveness indicators of the country and expressed as better scores and higher rankings converging towards the performance of the other euro area countries.

Testing Real Convergence as a Prerequisite for Long Run Sustainability

The main objective of this research is to estimate the degree of real convergence of the countries that joined the European Union between 2004–2013 as an essential precondition for sustainable accession to the Euro Area. Through this study, we tried to create a clear, real and comparative image for the downward trend in the dispersion of the GDP/capita and the speed by which countries with different integration stages achieve the real economic convergence to equilibrium level. In this respect, we tested real convergence by regression models. Further, in order to verify the robustness of the results we applied a cluster analysis. The main results show that non-Euro Area countries have a tendency to individually reduce income disparities with the Euro Area average, but do not register a convergent economic growth and do not form a homogeneous convergence cluster, unlike the newer Euro Area Member Countries. Another representative result is that the Czech Republic seems to be the best prepared country to adopt the single currency in a sustainable way, while Bulgaria is at the opposite pole.

One Money, Many Markets

Abstract We study heterogeneity in the transmission of monetary shocks across euro-area (EA) countries using a dynamic factor model and high-frequency identification. Deploying a novel methodology to asses the degree of heterogeneity, we find it to be low in financial variables and output but significant in consumption, consumer prices, and variables related to local housing and labour markets. We show that a large proportion of the variation in the responses to monetary shocks can be accounted for by differences in some characteristics of these markets across EA member countries: the share of adjustable mortgage contracts, homeownership rates, shares of hand-to-mouth and wealthy hand-to-mouth consumers, as well as wage rigidity.

The functioning of the credit market in the European Union and the consequences of legal regulations regarding the cost of credit on the example of Poland

The purpose of this work is to determine the level of financial obligations the borrower assumes when obtaining a loan in Poland, depending on the conditions under a credit agreement, circumstances related to getting and repayment of the loan. It is found that from to January 2008 to January 2021 in emerging market economies the level of credit to the non-financial sector in the percentage of GDP is increasing to 240%, in Member states of the Euro area - about 292%. The study found that in countries in the emerging market group, the level of financing increases much quickly than in Euro area. Thus, in January 2021 compared to January 2008, the level of financing (credit to non-financial sector from all sectors at market value) in emerging market economies has tripled, while in Euro area member countries this ratio increased on 33%. In Poland, the level of financing during mentioned period increased to 141.1% and as of January 2021 amounted to USD 881.8 bln. The development of bank lending is only possible if there is a transparent relationship between the banks and the borrowers that helps to minimize credit risk. The analysis of credit legislation in the EU countries made it possible to find that there is a problem with presentation of information on the calculation of the credit costs in a transparent and understandable way. It was established that the credit costs in Poland, taking into account its maximum level, can have a significant impact on the borrower’s creditworthiness and obtaining information on the «real» credit costs is necessary to make good decisions by a potential debtor. According to the results of the study, algorithms for calculating the credit cost were proposed, that make it possible to present all components of the costs and its level depending on the conditions for granting a loan. The results of the research can be used by potential borrowers before deciding to take a loan in a Poland bank to determine all the costs related to the loan. The research is in line with an idea of «economisation of law» or «financialisation of law».

Capital flows in the euro area and TARGET2 balances

This paper explores how the uneven recourse by national banking systems in the euro area to the ECB’s unconventional refinancing operations that led to the accumulation of large TARGET2 balances at the NCBs has contributed to the evolution of aggregate economic activity in important member states of the euro area. For the period between 2008 and 2014 we estimate a panel VAR model and identify the structural shocks by means of sign restrictions. Our results suggest that the build-up of TARGET2 balances was driven mainly by capital flow shocks while being barely responsive to other aggregate shocks. Furthermore, on the basis of counterfactual experiments we find that the ability to build up sizeable TARGET2 liabilities has contributed substantially to avoiding deeper recessions in the distressed euro area member countries like Spain, Italy, Ireland and Portugal, while to a smaller extent depressing aggregate economic activity in core member states such as Germany, the Netherlands and Finland.

Faktori koji obrazlažu spredove državnih svopova kreditnih neizvršenja - kvantilni pristup regresiji

This article aims to analyze the main risk factors that explain the manifestation and the aggravation of sovereign risk, particularly through the dynamics of sovereign CDS spreads in euro area member countries. The explanatory factors that will be analyzed are related to general risk aversion, which is explained by the volatility of the stock markets, liquidity risk perceived by the flight to quality phenomenon, idiosyncratic risk, which is explained by the deterioration of the state of macroeconomic fundamentals. We will adopt an econometric approach with the quantile regression method applied to panel data developed by Canay (2011), because it allows to estimate the effect of the independent variables on the different regions of the distribution, of the dependent variable and also makes it possible to overcome the problem of the presence of extreme values. Finally, our model has made it possible to identify, over time and different countries, the factors which significantly explain a sovereign risk, and whose deteriorated situation is likely to lead to payment defaults, which is very important to know, especially in the current unfavorable macroeconomic context. These include the volatility of the stock markets, which shows investor mistrust, the drying up of liquidity in the bond markets, which explains the phenomenon of flight to quality, the budgetary factor, which is explained by the unsustainable debt, and the economic factor, perceived by the level of wealth of a country.

Equilibrium real interest rates and the financial cycle: Empirical evidence for Euro area member countries

We estimate the equilibrium real interest rate for nine Euro area member countries and the Euro area as a whole using quarterly data from 1995 to 2015. We expand the standard model of estimating real equilibrium interest rates to incorporate the financial cycle for the private sector. We show that adding the financial cycle indeed alters the equilibrium real interest rate estimates and, in line with previous studies, that there is a fall in the equilibrium real interest rate over time. Our results indicate that in most member countries the real rate is lower than its equilibrium level. Hence, they should not worry about secular stagnation now. This is because secular stagnation is likely to occur when real interest rates are higher than their equilibrium levels. This result can serve as a starting point for further research in this field, e.g. by adding public sector financial cycles or disentangling the roles of households, corporations and the government.

US monetary policy and the euro area

This study documents empirically that contractionary US monetary policy may generate short-term expansionary spillover effects. In individual Euro Area (EA) member countries, economic activity increases, mainly via the trade channel. Also, domestic credit and stock markets expand, highlighting the importance of the financial channel. However, the international repercussions are transitory and distributed unevenly within the EA. The effect diminishes as EA interest rates increase with a few quarters delay. While the effects are heterogenous and rather large before 1999, responses become more homogeneous and smaller in size after the implementation of the euro. Still, country-specific asymmetries remain.

Capital Flows in the Euro Area and TARGET2 balances

We estimate a panel VAR model for the euro area to quantitatively assess how the uneven recourse of national banking systems in the euro area to the ECB's unconventional refinancing operations that led to the accumulation of large TARGET2 balances, has contributed to the propagation of different types of structural economic shocks as well as to the historical evolution of aggregate economic activity in euro area member countries in the period 2008-2014. Our results suggest that the built-up of TARGET2 balances was mainly driven by capital flow shocks while being barely responsive to other aggregate shocks. Furthermore, on basis of counterfactual experiments we find that the ability to build-up sizable TARGET2 liabilities has contributed substantially to avoid deeper recessions in the distressed euro area member countries like Spain, Italy, Ireland and Portugal, while to a smaller extent depressing aggregate economic activity in core member states, such as Germany, the Netherlands and Finland.

Patterns of Convergence (Divergence) in the Euro Area: Profitability Versus Cost and Price Indicators

We document that profitability—profit margins—has diverged in Euro-area countries since the introduction of the euro. Changes in profitability only partially overlap with changes in unit labour costs and producer prices, which are the indicators more commonly used in the literature to assess the competitiveness of euro-area member countries. We provide suggestive evidence that changes in profitability are correlated with changes in relative export performance, whereas the correlations between export and price and export and unit labour costs are unclear. We check the robustness of this correlation on a panel of 10 countries that adopted the euro between 1999 and 2001, and two-digit manufacturing sectors covering the period from 1999 to 2015, and conclude that profitability in the tradable sector is a useful indicator to assess the competiveness of euro-area countries. This is consistent with the recent international trade literature, according to which firms that export more are also more efficient or produce better products, as well as charging higher mark-ups.

Capital Flows in the Euro Area and TARGET2 Balances

We estimate a panel VAR model for the euro area to quantitatively assess how the uneven recourse of national banking systems in the euro area to the ECB's unconventional refinancing operations that led to the accumulation of large TARGET2 balances, has contributed to the propagation of different types of structural economic shocks as well as to the historical evolution of aggregate economic activity in euro area member countries in the period 2008-2014. Our results suggest that the built-up of TARGET2 balances was mainly driven by capital flow shocks while being barely responsive to other aggregate shocks. Furthermore, on basis of counterfactual experiments we find that the ability to build-up sizable TARGET2 liabilities has contributed substantially to avoid deeper recessions in the distressed euro area member countries like Spain, Italy, Ireland and Portugal, while to a smaller extent depressing aggregate economic activity in core member states, such as Germany, the Netherlands and Finland.

Export Hysteresis, Capacity Constraints, and Uncertainty: A Smooth Transition Analysis for Euro Area Member Countries

We argue that, under certain conditions described by a sunk cost hysteresis model, firms consider exports as a substitute for domestic demand. This is valid also on the macroeconomic level where the switch from the domestic market to the export market and vice versa takes place in a smooth manner. Areas of weak reaction of exports to changes in domestic demand are widened by uncertainty. Our econometric model for six euro area countries suggests domestic demand and capacity constraints as additional variables for export equations. We apply the exponential and logistic variant of a smooth transition regression model and find that domestic demand developments and uncertainty are relevant for short-run export dynamics particularly during more extreme stages of the business cycle. A substitutive relationship between domestic and foreign sales can most clearly be found for France, Greece, and Ireland (exponential smooth transition regression (ESTR) model) and France, Portugal, and Italy (logistic smooth transition regression (LSTR) model), providing evidence of the importance of sunk costs and hysteresis in international trade between the member states of the Economic and Monetary Union (EMU). What is more, our empirical results are robust to the inclusion of a variable measuring European policy uncertainty. In some cases (Italy, Greece, and Portugal) the results underscore the empirical validity of the export hysteresis under uncertainty model.

Neoclassical versus Kaldorian explanations of Southern Europe’s productivity slowdown

The productivity slowdown in European countries is among the major stylised facts of the last two decades. Several explanations have been proposed: some focus on demand-side effects, working through Kaldor’s second law of economic growth (also known as Verdoorn’s law), others on supply-side effects determined by a misallocation of the factors of production, caused either by labour market reforms or by perverse effects of financial integration (in Europe, related to the adoption of the euro). The latter explanation is put forward by some recent studies that stress how low interest rates brought about by the monetary union may have lowered productivity by inducing capital misallocation. The aim of this paper is to investigate the robustness of the latter empirical findings and to compare them with the alternative explanation offered by the post-Keynesian growth model, which instead emphasises the relation between foreign trade and productivity, along lines that go back to Adam Smith. To do so, we use a panel of industry-level data extracted from the EU KLEMS database, comparing these alternative explanations by panel cointegration techniques. The results shed some light on the role played by the single currency in the structural divergences among euro area member countries.

Equilibrium Real Interest Rates and Secular Stagnation: An Empirical Analysis for Euro Area Member Countries

AbstractIs secular stagnation – a period of persistently lower growth such as that seen following the financial crisis of 2008–09 – a valid concern for euro‐area countries? We tackle this question using the well‐established Laubach‐Williams model to estimate the unobservable equilibrium real interest rate and compare it to the actual real rate. In light of the considerable increase in heterogeneity among EU member countries since the beginning of the financial crisis, we apply our approach to 12 euro‐area countries to provide country‐level answers to the question of secular stagnation. The presence of secular stagnation in a number of euro‐area countries has important implications for ECB decision‐making (such as, voting power in the Governing Council) and EU governance. Our results indicate that secular stagnation is not a significant threat to most euro‐area countries, with one possible exception: Greece.

Beyond Balassa and Samuelson: real convergence, capital flows, and competitiveness in Greece

To better understand the convergence process prior and since the European financial and debt crisis, we scrutinize the role of capital flows for competitiveness in Greece and a set of six other euro area member countries (Portugal, Latvia, Estonia, Lithuania, Slovenia and the Slovak Republic). For this purpose the paper extends the seminal Balassa–Samuelson model by international capital markets with a particular focus on their impact on national wage policies. Capital flows are assumed to be able to invert the traditional direction of transmission of real wage increases from the tradable sector to the non-tradable sector and to make real wages increase beyond productivity increases. The augmented Balassa–Samuelson model is extended to trace cyclical deviations of real exchange rates from the productivity-driven equilibrium path. Panel estimations for the period from 1995 to 2013 reveal correlations in line with the Balassa–Samuelson effect, if Greece is excluded from the panel. For Greece, this in turn implies indication in favour of a credit-driven real wage increases beyond productivity increases what we call a “pseudo” Balassa–Samuelson effect.

Beyond Balassa and Samuelson Real Convergence, Capital Flows, and Competitiveness in Greece

We scrutinize the role of capital flows in competitiveness in a set of seven euroarea member countries (Estonia, Greece, Latvia, Lithuania, Portugal, Slovenia, and the Slovak Republic) in the context of real convergence and crisis. A specific focus is on Greece. The paper extends the seminal Balassa-Samuelson model to include international capital markets, placing a particular focus on their impact on national wage policies. Capital flows are assumed to be able to invert the traditional direction of transmission of real wage increases from the tradable sector to the non-tradable sector and to cause real wages to increase beyond productivity increases. The augmented Balassa-Samuelson model is extended to trace cyclical deviations of real exchange rates from the productivity-driven equilibrium path. Panel estimations for the period from 1995 to 2013 show evidence of the Balassa-Samuelson effect if Greece is excluded from the panel. For Greece, this in turn provides evidence in favour of capital inflow-driven real wage increases in excess of productivity increases.

Export Hysteresis, Capacity Constraints and Uncertainty: A Smooth-Transition Analysis for Euro Area Member Countries

We argue that, under certain conditions described by a sunk cost hysteresis model, firms consider exports as a substitute for domestic demand. This is valid also on the macroeconomic level where the switch from the domestic market to the export market and vice versa takes place in a smooth manner. Areas of weak reaction of exports to changes in domestic demand are widened by uncertainty. Our econometric model for six euro area countries suggests domestic demand and capacity constraints as additional variables for export equations. We apply the exponential and logistic variant of a smooth transition regression model and find that domestic demand developments and uncertainty are relevant for short-run export dynamics particularly during more extreme stages of the business cycle. A substitutive relationship between domestic and foreign sales can most clearly be found for France, Greece and Ireland (ESTR model) and France, Portugal and Italy (LSTAR model), providing evidence of the importance of sunk costs and hysteresis in international trade in these EMU member countries. What is more, our empirical results are robust to the inclusion of a variable measuring European policy uncertainty. In some cases (Italy, Greece and Portugal) the results underscore the empirical validity of the export hysteresis under uncertainty model.