Euro Area Member States Research Articles

Greening Central Bank Policies: Euro Area vs Non-Euro Area EU Member States

Abstract Climate change has become relevant for central banks worldwide, but they are adopting their instruments at different speeds. This article compares the reactions of the Eurosystem with those of the other EU central banks. Do these central banks differ in their efforts to make their own policies “greener”? The article argues that the options and constraints to react to climate change diverge between central banks.

ECB communication sentiments: How do they relate to the economic environment and financial markets?

In this paper we examine multiple dimensions of ECB monetary policy communication by identifying its sentiment and relation with the economic environment and financial markets. We quantify communication sentiment using transcripts from official ECB communication events – press conferences, accounts and Executive Board speeches – as well as media reactions that highlight the key messages of those events. Importantly, we create distinctive lexicons for both of those communication types. We find that the overall trends in the sentiment indices for the analysed communication events closely resemble the movements of monetary policy stance as well as inflation dynamics in the euro area, both before and after the COVID-19 shock period. The communication tone generally shifts in advance of actual monetary policy actions. Using regression analysis, we find some expected, statistically significant effects of press conference sentiment on bank stock prices (information-type shock) and identify the impact of Executive Board speeches on euro area risk-free rates. Fragmentation issues among euro area member states do not seem to be negatively affected by the sentiments of the ECB’s communication. Still, policy makers should be aware that the tone of their communication events is likely to affect particular financial markets. These results are confirmed by various robustness checks.

The impact of the heterogenous fiscal policy stance of euro-area member states on ECB monetary policy

This article assesses the influence of the fiscal stance of different euro-area members on the monetary policy actions of the European Central Bank. This issue has increased in relevance due to the widening disparities in the levels of debt across euro-area member states. We utilise a thick modelling approach that includes various GMM model specifications for the five largest euro area economies using quarterly projections data from 2002 to 2022. The findings indicate that the fiscal deficits of different euro area countries did not consistently exert a substantial impact on monetary policymaking. This conclusion holds even after the COVID-19 shock, with projected inflation remaining the most consistently significant indicator.

COVID-19 and public support for the Euro

The COVID-19 pandemic had disastrous effects on health and economic activity worldwide, including in the Euro Area. The application of mandatory lockdowns contributed to a sharp fall in production and a rise in unemployment, inducing an expansionary fiscal and monetary response. Using a uniquely large macro database, this paper examines the effects of the pandemic and the ensuing economic policies on public support for the common currency, the euro, as measured by the Eurobarometer survey. It finds that public support for the euro increased in a majority of the 19 Euro Area member states and reached historically high levels in the midst of the pandemic. This finding suggests that the expansionary fiscal policies initiated at the EU level significantly contributed to this outcome, while the monetary measures taken by the European Central Bank did not have a similar effect.

European Macroeconomic Dynamics on Financial Markets and Economic Policy: A Cross Country Study for Spillover Effects

Abstract What is the direction and extent of the spillover effects of sovereign bond yields in the European Union and which countries are transmitters and receivers of these effects? The motivation for this research is related to the need to better understand the interconnectedness of European Union sovereign bond markets in the context of rising budget deficits and public debt, as well as recent financial and sovereign debt crises, which have highlighted the importance of bond market interdependencies. The main objective of the paper is to investigate the direction and magnitude of the spillover effects of sovereign bond yields in the European Union and to identify the states that act as transmitters and receivers of these effects. The data used in the analysis include the evolution of the bond markets of the euro area member states and non-monetary union states, to allow comparison and assessment of their interconnectivity. To analyse the interconnectedness of bond markets, methods which provide a suitable analysis framework to assess volatility propagation between countries were used. The research results highlight that most of the contagion effects are concentrated in the peripheral countries, such as Romania, Portugal, Lithuania and Ireland, and the central countries act as transmitters of these effects.

Private bank deposits and macro/fiscal risk in the euro-area

We use a panel of ten euro area member states to examine the link between macro/fiscal risk and private bank deposits relative to Germany. Our main findings are summarised as follows: First, the relationship between relative deposits and macro/fiscal risk factors is not stable over time. Second, the significant time variation characterizing this relationship is driven by aggregate EMU-wide macro/fiscal risk conditions. Third, relative deposits in periphery EMU countries are generally more responsive to macro/fiscal risk. Fourth, the ECB’s unconventional monetary policy moderated the effect of the global financial and European debt crises on the relationship between relative deposits and macro/fiscal risk. Our empirical findings can inform the ongoing policy debate regarding the completion of the European Banking Union.

Oil news shocks, inflation expectations and social connectedness

While recent work has emphasized that production networks help in the propagation of oil shocks, this paper emphasizes the role of social connections in propagating the effect of oil shocks on inflation expectations. Using a dataset of Euro Area member states, the paper shows that social connectedness has a significant role in the propagation of oil shocks on inflation expectations, with the network effects dominating the direct effects. The effects have become stronger in recent years.

Government bond rates and interest expenditure of large euro area member states: A scenario analysis

AbstractThis paper assesses the possible development of government interest expenditures for Germany, France, Italy and Spain. Until 2021, governments could anticipate a substantial further reduction in interest expenditure. This outlook has changed drastically with the surge in inflation and government bond rates. Assuming that bond rates remain at the levels implied by yield curves from December 2022, interest expenditure rises substantially. We also examined scenarios with a further upward shift in yield curves by one or two percentage points. They indicate major medium‐term risks for highly indebted member states with interest expenditure approaching or exceeding levels last observed on the eve of the euro area debt crisis. Governments should take action to achieve a decline in debt‐to‐GDP ratios towards safe levels. They need to make sure public debt remains sustainable at the higher interest rates that are required to achieve price stability in the euro area.

EU or Euro Area Crisis? Studying Differentiated Integration as an Idea Structuring Elite Perceptions of the Sovereign Debt and the COVID-19 Crisis

ABSTRACT After the sovereign debt crisis, scholars concluded that euro area member states (EAMS) and non-EAMS embarked on diverging paths of integration. Yet, their united response countering the economic consequences of the COVID-19 crisis contradicts the path-dependency argument. This article takes an ideational approach. It demonstrates that the different crisis outcomes regarding differentiated integration (DI) in Economic and Monetary Union (EMU) coincide with variations of how DI influenced elite crisis perceptions as an idea. While policymakers perceived the sovereign debt crisis as a currency area crisis with threats and spillovers applying to EAMS, they interpreted the COVID-19 crisis as a health emergency threatening all EU member states. These differences in elite crisis perceptions facilitated different outcomes regarding DI despite unchanged economic and fiscal circumstances among EAMS and non-EAMS. The findings challenge deterministic assumptions on the self-reinforcing nature of DI in EMU and establish DI as an idea structuring elite perceptions.

Determinants of macroeconomic resilience in the euro area: An empirical assessment of national policy levers

This paper evaluates which structural characteristics matter for macroeconomic resilience, in particular regarding the capacity to absorb and recover from common shocks across euro area Member States over the period from 1998 to 2018. Applying a panel regression analysis and Bayesian model averaging, the paper aims to identify a set of factors as diverse and specific as possible in order to guide future policy actions. These country-specific factors relate to the macroeconomic conditions, the functioning of product, labour and financial markets, institutional quality and to deeply entrenched structural factors. The empirical analysis suggests that the factors conditioning the shock absorption across euro area Member States largely differ from those facilitating recovery in the face of a common shock. More specifically, labour market features play an important role in shock absorption with higher levels of labour market rigidity dampening the shock absorption capacity most. The recovery capacity is affected by a broader set of factors, especially those that hinder the reallocation of labour as well as of the production of goods and services. While high public debt seems to hinder shock absorption capacity, high private debt weakens the recovery capacity. Some factors such as high economic openness have a negative impact on the absorption capacity in case of a common shock as it also affects trading partners, while having a positive impact on the recovery capacity. The results also suggest that degrees of macroeconomic resilience differ across the euro area and well-calibrated reforms are needed to address the nexus of country-specific challenges.

The ECB’s Unconventional Monetary Policy Effects on the Economies of Bulgaria and Ireland

This paper analyzes the impact of the ECB’s euro short-term interest rate – the Euro overnight index average (EONIA) – on the long-term government bond yields in one economy in the non-euro area (Bulgaria) and one economy in the euro area (Ireland) through the interest rate transmission channel. The paper’s main contention is that the ECB’s non-standard monetary policy directly affects the euro area member states, such as Ireland. At the same time, its impact on the changes in the interest rates in Bulgaria is indirect. The result from the econometric modeling demonstrates that if EONIA rises by 0.1 percentage point, the yields on the long-term government bonds in Ireland and Bulgaria will increase, respectively, by 0.175 and 0.123 percentage points. Given fixed levels of EONIA each month, the interest rates on the 10-year government bonds in Ireland and Bulgaria are expected to decline, respectively, by 0.006 and 0.036 percentage points. The large-scale bond-buying programmes and the negative deposit rates have driven significant increases in negative-yielding debt in the euro area, including in Ireland. In contrast, Bulgaria’s long-term government bond yield is positive but dropped significantly during the reviewed period (January 2012 to December 2020).

Only if You Play by the Norms! Insider Norms and Outsider Involvement in Eurogroup and Eurogroup Working Group Interaction During the Sovereign Debt Crisis

AbstractReflections on the sovereign debt crisis often portray the Eurogroup and the Eurogroup Working Group (EWG) as inaccessible for euro area outsiders. Yet, common wisdom suggests that Council representatives can circumvent exclusion due to differentiated integration (DI) by complying with insider norms. This article studies whether and how compliance with procedural norms socialised amongst representatives from euro area member states (EAMS) determined patterns of non‐EAMS involvement in Eurogroup and EWG interaction during the sovereign debt crisis. The argument highlights the role of deliberation and consensus‐building norms, suggesting that they gained particular robustness amongst EAMS representatives. Those non‐EAMS representatives who consistently complied with these insider norms could secure involvement in intergovernmental debates amongst EAMS. Exclusion was mostly relevant to norm violators. This article sheds light on the institutional consequences of DI in Economic and Monetary Union, highlighting its structural effects on governance and decision‐making processes during the sovereign debt crisis.

Risk sharing and the adoption of the Euro

This paper empirically evaluates whether adopting a common currency has changed the level of consumption smoothing of euro area member states. We construct a counterfactual dataset of macroeconomic variables through the synthetic control method. We then use the output variance decomposition of Asdrubali et al. (1996) on both the actual and the synthetic data to study if there has been a change in risk sharing and through which channels. We find that the euro adoption has reduced risk sharing and consumption smoothing. We further show that this reduction is mainly driven by the periphery countries of the euro area who have experienced a decrease in risk sharing through private credit.

Kryzys strefy euro i nowe wyzwania dla demokracji i praw podstawowych w Unii Europejskiej

The outbreak of the global financial crisis in 2007 exposed numerous structural flaws in the architecture of the euro area. From today’s perspective, it is known that without quick action going beyond the legal framework of the treaties and the competences of EU bodies, the euro area would most likely collapse. These design flaws are slowly being removed through the implementation of “unconventional” monetary policies conducted by the European Central Bank, as well as by new institutional tools aimed at increasing the coordination of economic policies and supervision over the financial condition of individual euro area Member States. With these changes, fundamental questions have arisen about the legitimacy of emergency reforms. The state of emergency has been lifted, but questions about the legitimacy of the new competences and methods in overseeing the euro area leave doubts as to their compliance with the principles of democracy and respect for fundamental rights. The aim of the article is to present the challenges related to the current and postulated shape of the Eurozone reforms seen through the prism of European fundamental values, i.e. democracy and human rights.

Proposals for Institutional Changes in the Management of the Euro Area: Euro Area Treasury, European Minister of Economy and Finance, European Monetary Fund

European Union member states which have been outside the euro area are obliged to join it as soon as they are able to fulfil the necessary convergence criteria. As a result of the financial crisis of 2008 and the consequences following it, euro area member states have adopted additional rules regulating its functioning which make the accession to the euro area even more difficult for those concerned. In addition to this some member states and EU institutions have proposed other measures which have as their aim to establish new institutions and organs involved with the management of the euro area.
 The present paper aims at describing three of those institutions (the Euro Area Treasury, European Minister for Economy and Finance, European Monetary Fund) and to evaluate the potential impact of their entry into force on those member states who (as Poland and Czechia) have been outside the euro area. In order to achieve this aim the author analyses proposed changes in more details and provides an assessment.

Analysis of the effects of fiscal policy shocks in the Baltic region

The study aims to compare the effects of fiscal policy shocks in three Baltic countries – Estonia, Latvia, and Lithuania - within SVAR framework, using the identification scheme proposed by Blanchard and Perotti (2002). The time sample covers quarterly data over the period of 2002q1-2019q4. The main idea of the study is to identify the effects of fiscal policy shocks in three euro area member states under a single monetary policy of the European Central Bank, but with country-specific fiscal policy shaped by the European fiscal framework. The results show that, generally, in the short term (up to four quarters), output reacts consistently with the Keynesian view, emphasizing the importance of using discretionary fiscal policy tools in stimulating economic activity in the Baltic region. However, in Estonia and Latvia, the calculated impact multipliers for net taxes are larger than spending multipliers. Although each country reacts differently to its country-specific fiscal shock, the response to the euro area money market interest rate innovation is quite similar with respect to the direction of the effect, which may indicate the robustness of the Baltic region in terms of the euro area shocks. Thus, the results emphasize the importance of conducting domestic fiscal policy adapted to the conditions of each of the analysed economies. Based on the assumptions and the methodology used in this study, the obtained findings show the limited effects of spending on Baltic economies in comparison with the effects caused by the shocks in net taxes. Moreover, due to the lack of large-scale analysis regarding the effectiveness of fiscal policy in Baltic states, the obtained results are a valuable contribution to the debate about the ‘appropriate’ size of the fiscal multipliers for the Baltic region.

Breakdown of Government Debt into Components in Euro Area Countries

The pandemic that erupted in 2020 generated a significant increase in public debt, which is likely to draw the attention of economic policy and the economic profession to the evolution and sustainability of debt. This study first shows how the gross sovereign nominal consolidated government debt of the euro area member states developed between 2011 and 2019. Using conventional breakdown and correlation calculation methods, the study analyzes how closely the three components are related to the government debt ratio. The three components are: budget balance, economic growth, and real interest rates. The study then groups the member states into groups using the hierarchical cluster analysis of the SPSS program. The “composite” rankings formed on the basis of the correlation coefficients proved to be well-understood, and the examined countries were given a clear position within the cluster. Finally, a verbal macroeconomic analysis of the member states in the same group follows in terms of the relevance of each component in the evolution of their public debt. The analysis shows that each independent variable had a significantly different effect on the change in the government debt ratio of each member state. The results and the correlations established can also be used later to examine the sustainability of public debt in the euro area.

Do Large TARGET2 Balances Bear Risks for the Euro Area?

Large increases in TARGET2 balances in the euro area since 2008 have led to concern and debate about the appropriate interpretation and policy reaction – in particular in TARGET2 creditor countries such as Germany. Against this background, we examine the main drivers of the increases and asymmetries in TARGET2 balances that have emerged in the context of the financial and sovereign debt crises as well as in the context of the Eurosystem’s implementation of quantitative easing (QE) and the COVID-19 pandemic. Moreover, this paper analyzes the potential risks for euro area member states in the case of (i) the unchanged continuity of the monetary union, (ii) the withdrawal of a member state with (large) TARGET2 liabilities, and (iii) the break-up of the whole monetary union. Depending on the outcome of exit negotiations and the operational handling, there can be direct risks in the form of default losses of TARGET2 balances and indirect risks in the form of threat potentials if TARGET2 debtor countries pretend to plan to leave the euro area. Based on this, we discuss adaption options for the TARGET2 payment system and consider an exit from the ECB’s accommodative monetary policy in order to scale back the high amount of excess liquidity in the euro area banking sector which is the prerequisite for the emergence of TARGET2 balances.

How harmful are cuts in public employment and wage in times of high unemployment?

AbstractSince 2010, and in line with austerity measures, public employment and public‐sector compensations to employees have been significantly reduced in most Euro Area member states and particularly in Spain and Greece. At the same time, unemployment in these two economies was greatly increasing. In a dynamic and stochastic general equilibrium (DSGE) model, we demonstrate that these cuts in public employment and wages are more damaging in terms of output and employment losses in periods of high unemployment. The model is able to produce significant state dependence of fiscal multipliers. Main results can be summarized as follows: (1) Public‐sector wages shocks produce larger multipliers than public‐sector employment shocks; (2) with a higher steady‐state unemployment, response of non‐Ricardian consumption to fiscal shocks are worse while Ricardian households consumption is better off, thanks to lower inflation following fiscal shocks and a higher marginal utility of consumption at the high‐unemployment steady state; (3) a larger share of non‐Ricardian households, a higher job separation rate, and a lower matching efficiency amplify fiscal multipliers; (4) a passive monetary policy increases fiscal multipliers in the case of public vacancy shocks but dampens multipliers associated with cuts in public‐sector wages; and (5) fiscal multipliers are larger when demand and supply shocks hit the economy, to a greater extent in the case of a negative shock on aggregate demand.

Debt Relief as a Last Resort for the Lender of Last Resort?

The coronavirus crisis has led to a sharp increase in the debt-to-GDP ratios of the euro area member states. Without external support, access to the capital market could be seriously threatened in the medium term for Italy, but also for other member states. While the Pandemic Emergency Purchase Programme, which is designed as a monetary policy instrument, is regarded by some as a violation of the prohibition of monetary financing, the Next Generation EU recovery fund is likely to direct the fundamental structures of the European Union towards a fiscal union with considerable redistribution elements. This article analyses an alternative strategy, namely debt relief by the European System of Central Banks through an EU debt agency. Such a scheme would be possible without amending the EU treaties and would avoid negative equity at the central banks. The question is under what circumstances would this approach be suitable and proportionate?