Euro Area Research Articles

The Euro Area: Conventional Theory and a Digital Future

The Euro Area: Conventional Theory and a Digital Future

The Euro Area Government Spending Multiplier in Demand‐ and Supply‐Driven Recessions

AbstractWe estimate government spending multipliers in demand‐ and supply‐driven recessions for the Euro Area. Multipliers in a moderately demand‐driven recession are two to three times larger than in a moderately supply‐driven recession, with the difference between multipliers being non‐zero with very high probability. More generally, multipliers are inversely correlated with the deviation of inflation from its trend, implying that the more demand‐driven a recession, the higher the multiplier. Multipliers range from 0.5 in supply‐driven recessions to about 2 in demand‐driven recessions. The econometric approach leverages a factor‐augmented interacted vector‐autoregression model purified of expectations (FAIPVAR‐X). The model captures the time‐varying state of the business‐cycle including strongly and moderately demand‐ and supply‐driven recessions, by taking the whole distribution of inflation deviations from trend into account.

The effect of fragmentation risk on monetary conditions in the euro area

This paper measures the output effects of financial fragmentation in the euro area by estimating an extended IS curve. Using a panel approach, we find that two fragmentation measures are significantly related to the output gap: sovereign spreads and spreads in the long-term cost of borrowing of the private sector. We use these output effects to construct a Monetary Conditions Index (MCI) for euro area countries. This index summarizes the combined effect of the monetary policy stance and financial fragmentation. We show that the MCI approach is well-suited to capture cross-country differences in a fragmentation-enhanced measure of the monetary policy stance. Using this metric, we find that during the sovereign debt crisis, the cross-country dispersion of MCI's based on sovereign spreads was much larger than that based on the private cost of borrowing. We also show that convergence is slower for MCI's based on sovereign spreads. We conclude that the causes of fragmentation in monetary conditions may change over time, and that this has implications for the appropriate policy response.

Shopping behavior and the effect of monetary policy on inflation heterogeneity along the income distribution

This paper studies the effect of monetary policy on inflation along the income distribution in the euro area and shows that monetary policy has differential effects. In response to monetary tightenings, high-income households engage in more intense product substitution and trade down in the product and store space relative to low-income households, such that their inflation responds relatively more. This channel stands in contrast to the effect arising from different consumption bundles, which imply that the inflation experienced by high-income households responds less to monetary policy. The paper also reveals substantial cross-country heterogeneity, with the product substitution channel being more pronounced in countries where price differences between possible substitutes are larger.

Latent fragility: Conditioning banks' joint probability of default on the financial cycle

We propose the CoJPoD, a novel framework explicitly linking the cross-sectional and cyclical dimensions of systemic risk. In this framework, banking sector distress in the form of the joint probability of default of financial intermediaries (reflecting contagion from both direct and indirect interconnectedness) is conditioned on the financial cycle (reflecting the buildup and unwinding of system-wide balance-sheet leverage). An empirical application to large systemic banks in the euro area, US and UK illustrates how the unraveling of excess leverage can magnify banking sector distress, including during the 2023 US banking sector turmoil. Capturing this dependence of banking sector distress on prevailing financial imbalances can enhance risk surveillance and stress testing alike. An empirical signaling exercise confirms that the CoJPoD outperforms the individual capacity of either its unconditional counterpart or the financial cycle in signaling financial crises – particularly at their onset – suggesting scope to increase the precision with which macroprudential policies are calibrated.

The driving effect of the Euro on inbound tourism: multiperiod DID method

The introduction of the euro has greatly increased the amount of inbound tourists. The paper employs a multiperiod difference-in-differences (DID) model aimed at investigating the impact of the introduction of the euro on inbound tourism in 19 member states of the European Monetary Union (EMU) during 2002–2018. The results show that the euro has a significantly positive impact on international tourist arrivals and international tourism receipts in euro area countries. Moreover, there are also quantile differences in this effect. With increasing quantile levels, the quantile regression coefficients of the euro on international tourist arrivals are increasing, and the quantile regression coefficients of the euro on international tourism receipts are decreasing. Furthermore, the impact of the euro on international arrivals and international tourism receipts has been on the rise as the increase in the number of years of Eurozone accession, but the rate of growth is slowing, and the impact of the euro on inbound tourism has fluctuated with the European debt crisis. These results highlight that although the euro has a positive and significant effect on both international tourist arrivals and international tourism receipts, they are found to have different patterns and trends through the decomposition of quantile regression and segmented regression.

Revisiting the estimation of the cost of equity of euro area banks

El objetivo de este artículo es estimar el coste de capital de una amplia muestra de entidades de crédito del área del euro. Con este fin, los autores consideran varias metodologías de estimación bajo dos enfoques principales: i) modelos de series temporales multifactoriales de rendimientos bursátiles, y ii) modelos de descuento de dividendos. Se observa que, a escala nacional, las estimaciones de los distintos modelos muestran una variación temporal similar, pero las diferencias en niveles pueden ser considerables. La relación entre las distintas estimaciones de coste de capital y los observables bancarios es relativamente débil. Las estimaciones de los modelos de descuento de dividendos muestran una relación algo más sólida con los fundamentos bancarios, mientras que las de los modelos de factores lo hacen más claramente solo para las entidades de mayor tamaño. Una medida combinada, construida como un promedio simple entre modelos, también muestra una asociación moderada con los fundamentos. En general, los resultados destacan las incertidumbres inherentes a la estimación del coste del capital y la importancia de considerar diferentes modelos alternativos.

Revisiting the estimation of the cost of equity of euro area banks

The aim of this article is to estimate the cost of equity for a large sample of euro area banks. To this end, the authors consider several estimation methodologies falling under two main approaches: (i) multi-factor time-series models of stock market returns; and (ii) dividend discount models. It is found that, at country level, the estimates of the various models display a similar time variation, but differences in levels can be substantial. The relationship between the different cost of equity estimates and bank observables is relatively weak. Estimates from dividend discount models show a somewhat more robust relationship with bank fundamentals, while those from factor models do so more clearly only for larger banks. A combined measure built as a simple average across models also shows a moderate association with fundamentals. Overall, the results highlight the uncertainties inherent in cost of equity estimation and the importance of considering different alternative models.

Spillovers from tax shocks to the Euro area

Abstract I study the spillover effects of legislated discretionary tax changes in the USA, Germany, and the UK to a panel of eleven Eurozone countries for the period 1980Q1–2018Q4 employing Local Projections. When considering aggregated tax shocks, I find little evidence for significant spillovers. When allowing for state-dependent effects, I find no effects of German or US tax cuts regardless of the state of the business cycle. When allowing for asymmetric effects, there is, in general, evidence for negative (positive) spillovers from US, German, and UK tax hikes (UK tax cuts). US tax hikes always cause adverse spillovers, whereas the effects for Germany and the UK are state dependent. When considering country-specific effects, the effects turn out as heterogeneous across the Eurozone countries. UK tax cuts are generally expansionary, whereas US (German) tax cuts cause positive spillovers mainly during recessionary (non-recessionary) times.

Commodity markets and the global macroeconomy: evidence from machine learning and GVAR

Based on a strongly data-intensive machine learning approach, this study first identifies the most essential globally traded commodities in view of their role for the global macroeconomic performance. At the second stage we estimate a global vector autoregressive model to assess in more detail these global reactions. Our results from the first stage indicate that of the 55 analyzed commodity markets, only four are revealed as the most important. At the second step, our GVAR analysis indicates that the commodity market effects on macroeconomic activity are neither unanimous across the commodities nor across macrovariables. As an overall result, the commodity market exposure is clearly stronger among the advanced countries such as the euro area, other developed economies, and China, compared to the emerging economies of Africa, Asia, and Latin America, at both the country and regional levels. This puts a lot of pressure on economic policies aimed at reducing, e.g., the depriving effects of commodity market price development on aggregate economic performance of these countries.

Geopolitical risk and stock prices

This paper investigates the effects of global geopolitical risk on stock prices of 29 economies by using the local projections method for the monthly period between 1985M1-2023M9. The results show that a positive unit shock of global geopolitical risk (normalized to one standard deviation) reduces stock prices (normalized to one standard deviation) in a statistically significant way by 0.80 in Latvia, 0.71 in China, 0.62 in the Euro Area, 0.50 in Sweden, 0.42 in the United Kingdom, 0.39 in the United States, 0.38 in Switzerland, 0.34 in Israel, 0.28 in Canada, and 0.21 in Denmark in a year following the shock, whereas it increases those only in Iceland by 0.28 that can be used to hedge against any geopolitical risk. Subsample analyses further suggest that the negative effects of the same shock exist in several economies (including the United States, China and Euro Area) during the first half of the sample period that coincides with the geopolitical events that the United States is involved with, whereas they only exist in Russia, Poland, Euro Area and the United Kingdom for the second half of the sample period, suggesting that the Russo–Ukrainian War has mostly affected the stock prices in these nearby economies. It is implied that the geographical location of geopolitical events as well as the countries involved are important indicators to understand the effects of any global geopolitical risk on stock prices.

How does inflation propagate among CPI components? Evidence from the euro area

This study employs a time-varying parameter vector autoregressive (TVP-VAR) model to investigate infla- tion propagation and spillovers among twelve major Consumer Price Index (CPI) components across eleven euro area countries from 1999 to 2023. We uncover empirical regularities in the transmission channels of inflation, noting Transport and Clothing and Footwear as primary shock transmitters, whereas Communi- cation, Alcohol and Tobacco consistently absorb shocks. These insights, consistent across various contexts and countries, contribute to understanding inflation persistence and households’ inflation experiences in the Euro area.

Unconventional monetary policy and policy foresight

What are the effects of unconventional monetary policy interventions on the economy? Empirical studies utilizing traditional SVAR models consistently report expansionary effects on output and prices while considering only a small number of variables. This paper is the first to present both narrative and empirical evidence indicating that these models are susceptible to policy foresight, as central banks frequently announce their unconventional policies months in advance. To address policy foresight, we estimate a Bayesian FAVAR model with an extended set of information for the Euro Area. Consistent with the existing literature, we find that an unconventional monetary policy shock boosts economic activity by increasing industrial production and reducing the unemployment rate. Notably, our estimated effects are both larger and more persistent compared to previous findings. Furthermore, the shock decreases interest rates, interest rate spreads, and government bond yields, leading to an improvement in financial conditions. In a noteworthy departure from previous research, we find significant uncertainty regarding the impacts on consumer and producer prices, highlighting the need for further research.

Consumer participation in the credit market during the COVID-19 pandemic and beyond

Abstract This article analyses the consumer’s decision to apply for credit and the probability of the credit being accepted in the euro area during a period characterized by the unprecedented concomitance of events and changing borrowing conditions linked to the global coronavirus disease 2019 (COVID-19) pandemic and the Russian invasion of Ukraine. We use data between 2020Q1 and 2023Q2 from the ECB’s Consumer Expectations Survey. We find that credit demand is the highest when the first lockdown ends and it drops when supportive monetary compensation schemes are implemented. There is evidence that constrained households are significantly less likely to apply for credit. Credit is more likely to be accepted under favourable borrowing conditions and after the approval of national recovery plans. We also find that demographic, economic factors, perceptions, and expectations are associated with the demand for credit and the credit grant.

Does one size fit all in the Euro Area? Some counterfactual evidence

This paper examines whether Euro Area countries would have faced a more favorable inflation output variability tradeoff without the Euro. We provide evidence supporting this claim for the periods of the Great Recession and the Sovereign Debt Crisis. The deterioration of the tradeoff becomes insignificant only after Draghi’s ‘whatever it takes’ announcement. Results show that the detrimental effect of the Euro is more severe for peripheral countries. We base our results on a novel empirical strategy that, consistent with monetary theory, models the joint determination of the variability of inflation and output conditional on structural supply and demand shocks.

The 2012 Greek Retrofit and Borrowing Costs in the European Periphery

This article examines the impact of Greece retroactively, via legislation, changing the terms in hundreds of billions of euros worth of Greek government bonds governed by domestic Greek law. As the abrogation of gold clauses in US government bonds by the US Congress in 1933 had been, the Greek action was decried as violative of the rule of law and sure to negatively impact the future ability of Euro area sovereigns to borrow. We test whether the Greek action had negative spillovers on European government debt markets. We find no evidence of increased borrowing for even the most peripheral European economies from the Greek action.

Balance sheet expansionary policies in the euro area: Macroeconomic impacts and a vulnerable versus non-vulnerable comparison

This paper investigates the impacts and heterogeneity of the ECB's large-scale asset purchasing programs of sovereign securities on real GDP, inflation, long-term sovereign bond yields, systemic stress, and the unemployment rate. A structural Bayesian VAR model with six endogenous variables was estimated for 11 euro area countries over the period 2012:M1 to 2023:M12. To provide robustness to the results, a structural panel BVAR model is estimated, enabling a straightforward comparison of impulse responses of vulnerable and non-vulnerable countries. The results suggest that the magnitudes of impulse responses were more favorable in countries that were more economically and financially vulnerable. These findings underscore that financial and economic distress was a source of heterogeneity in the responses to large scale asset purchases within the euro area.

The impact of Covid‐19 on banking groups’ balance sheets in the euro area

AbstractMost studies have found that the Covid‐19 pandemic did not negatively impact the euro area banking industry's performance at an aggregate level. This study explores whether this finding still holds using the return on assets of 16 banking groups operating in the euro area and considering bank‐specific factors, idiosyncrasies related to different exposures of their portfolios to the business cycle and weaknesses stemming from underlying structural vulnerabilities. The banking groups are classified into clusters using unsupervised learning techniques. This research contributes to the empirical literature on the determinants of banks’ performance by highlighting the importance of banks’ heterogeneity, notably controlling for differential performance due to asset quality, solvency and business model. In addition, this paper shows that the magnitude of return on assets’ exposure to the business cycle varies across banks and that inflation in the euro area matters only for a subset of them. Importantly, the study sheds some light on the possible reasons for the mixed results in the literature regarding the role of non‐interest income, the T1 capital ratio and inflation. Finally, no significant effects of the Covid‐19 variables on banks’ return on assets are found during the first seven quarters of the pandemic.

Inspecting cross-border macro-financial mechanisms

We model structural time-varying macro-financial linkages between the U.S. and euro area using a large dataset for each region. We extract both real and financial cycles and identify shocks, using a factor model with drifting parameters. To interpret the mechanisms that drive the empirical results, we contextualize our estimates using a two-country financial accelerator model. Our evidence speaks clearly of an asymmetric cross-border transmission between U.S. and euro area, especially in the financial domain. This is confirmed by our theoretical complement, which shows a strong transmission of U.S. TFP shocks. Moreover, the U.S. is a more leveraged economy, which accentuates the financial accelerator effect.

Nowcasting Euro area GDP with news sentiment: A tale of two crises

SummaryThis paper shows that newspaper articles contain signals that can materially improve real‐time nowcasts of real GDP growth for the Euro area. Using articles from 15 popular European newspapers, which are machine translated into English, we create sentiment metrics that update daily and assess their value for nowcasting, comparing with competitive and rigorous benchmarks. We find that newspaper text is especially helpful early in the quarter before other indicators are available. We also find that general‐purpose sentiment measures perform better than more economics‐focused ones in response to unanticipated events and nonlinear supervised models can help capture extreme movements in growth but require sufficient training data to be effective.