Largest Euro Area Countries Research Articles

Where do they care? The ECB in the media and inflation expectations

ABSTRACT This paper examines how news coverage of the European Central Bank (ECB) affects consumer inflation expectations in the four largest euro area countries. Utilizing a unique dataset of multilingual European news articles, we measure the impact of ECB-related inflation news on inflation expectations. Our results indicate that German and Italian consumers are more attentive to this news, whereas in Spain and France, we observe no significant response. The research underscores the role of national media in disseminating ECB messages and the diverse reactions among consumers in different euro area countries.

Forecasting housing investment

AbstractThis study applies a model averaging approach to conditionally forecast housing investment in the largest Euro area countries and the Euro area. To account for substantial modeling uncertainty, it estimates a large and diverse number of vector error correction models using a wide set of long‐ and short‐run determinants and applies subset selection based on in‐sample and out‐of‐sample criteria. First, a pseudo out‐of‐sample forecast exercise shows that our model averaging approach consistently beats a battery of distinguished benchmark models, including BVARs, FAVARs, LASSO, and Ridge regressions. This evidences that model averaging provides more accurate forecasts also in the case of housing investment. Second, we find remarkable cross‐country heterogeneity in the drivers of housing investment. Overall, these findings guide forecasters and modelers on improving housing investment models and policymakers on implementing country‐specific housing market policies.

Sources of Economic Policy Uncertainty in the euro area

We create economic policy uncertainty (EPU) indicators for the four largest euro area countries by applying two unsupervised machine learning algorithms to news articles. The procedure allows to uncover components of EPU endogenously for the four European languages. The uncertainty indices computed from January 2000 to May 2019 capture episodes of regulatory change, trade tensions and financial stress. In an evaluation exercise, we use a structural vector autoregression model to study the effects of uncertainty on investment and on private consumption. We document considerable effects for the political and domestic regulation uncertainty components on investment, while the other types show heterogeneous effects across countries. For instance, trade uncertainty influences Germany’s investment more than its counterparts. Moreover, we observe strong negative effects of uncertainty on consumption for countries such as Italy (political) and Spain (fiscal, political and domestic regulation).

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.

Fiscal space in the COVID-19 pandemic

ABSTRACT The ‘Great Lockdown’ in response to the COVID-19 pandemic has led to a severe world-wide economic crisis. In the euro area countries sovereign debt-to-GDP ratios are on the rise and reductions in expected fiscal surpluses raise sustainability concerns amongst investors. This paper provides novel estimates of non-linear state-dependent fiscal limits for the five largest euro area countries. Within the DSGE model I build a COVID-19 scenario calibrated to match the decline in real GDP growth forecasts between February and April 2020 and the fiscal stimulus packages announced until the end of March 2020. On average, fiscal space contracts by 58.4% of national GDP.

Liquidity Spill-Overs in Sovereign Bond Market: An Intra-Day Study of Trade Shocks in Calm and Stressful Market Conditions

The purpose of this paper is to determine the liquidity spillover effects of trades executed in European sovereign bond markets and to assess the driving factors behind the magnitude of the spill-overs between different markets. The one minute-frequency limit order-book dataset is constructed from mid-2011 until end-2017 for sovereign bonds from the six largest euro area countries. It is used for the event study and panel regression model. The event study results revealed that liquidity spill-over effects of trades exist and vary highly across different order types, direction and size of the trade, the maturity of traded bonds, and various markets. The panel regression model showed that less liquid bonds and bonds whose issuer is closer by distance to the country of the traded bond have more substantial spillover effects and, at the same time, are also more affected by trades executed in another market. These results should be of interest to bond market participants who want to limit the exposure to the liquidity spillover risk in bond markets.

Cyclical drivers of euro area consumption: What can we learn from durable goods?

We study the cyclical dynamics of consumption in the euro area (EA) and the large EA countries by distinguishing durable from nondurable expenditures. We adopt a theoretical partial equilibrium framework to justify the identification strategy of our empirical model, a time-varying parameter structural vector autoregression (TVP-SVAR). Following the main insight from the theoretical model, that liquidity constraints induce important interactions between durables and nondurables, we distinguish durable-specific demand and supply shocks, while taking into account monetary and credit conditions. Our main findings are: (i) durables react faster and more strongly than nondurables after monetary shocks in the euro area and in the largest EA countries, a confirmation of an outcome commonly reported for the US; (ii) there is a large degree of cross-country heterogeneity in how different factors (including durable-specific ones) explain consumption; (iii) the strength of spillovers from durable to nondurable consumption, as predicted by theory, is empirically correlated with how much households across countries are likely to be liquidity constrained.

Fiscal Sustainability during the COVID-19 Pandemic

The Great Lockdown implemented in response to the COVID-19 pandemic has led to a severe world-wide economic crisis. In euro area countries, sovereign debt-to-GDP ratios are on the rise and reductions in expected fiscal surpluses raise sustainability concerns amongst investors. This paper provides novel estimates of non-linear state-dependent fiscal limits based on Bi (2012) for the five largest euro area countries. Within the DSGE model I build a COVID-19 scenario calibrated to match the decline in real GDP growth forecasts between April and February 2020 and the fiscal stimulus packages announced up to the end of March 2020. On average, fiscal space contracts by 58.4 percent of national GDP. In a worst-case scenario fiscal space is 28.6 percent for Italy and 65.9 percent of national GDP for Germany.

Overlooked in the Debate? Non-Price Competitiveness in the Five Largest Euro Area Countries

This paper obtains a comprehensive measure of non-price competitiveness factors (NPCFs) based on a simple international trade model. Trade frictions are reinterpreted as the NPCF’s conditions (inferior product quality, and suboptimal geographical and industry specialization of exports) that inhibit trade. The setup is applied to the five largest Euro Area economies for the period 2000-2017. NPCF have improved significantly in the Netherlands and Spain, mildly in Italy and Germany, and mildly worsened in France. This result helps explain the Spanish ’paradox’. It also suggests that the conventional North-South divide in the Euro Area might not be entirely applicable regarding NPCF.

On the credit and exchange rate channels of central bank asset purchases in a monetary union

Throughout the euro area crisis, financial fragmentation across jurisdictions became a prime concern for the single monetary policy. The ECB broadened the scope of its instruments and enacted a series of non-standard measures to engineer an appropriate degree of policy accommodation. The transmission of these measures through the currency union remained highly dependent on the financial structure and conditions prevailing in various regions. This paper explores the country-specific macroeconomic transmission of selected non-standard measures from the ECB using a global DSGE model with a rich financial sector: we extend the six-region multi-country model of Darracq Pariès et al. (2016), introducing credit and exchange rate channels for central bank asset purchases. The portfolio rebalancing frictions are calibrated to match the sovereign yield and exchange rate responses after ECB's Asset Purchase Programme (APP) first announcement. The domestic transmission of the APP through the credit intermediation chain is significant and quite heterogenous across the largest euro area countries. The introduction of global portfolio frictions on euro area government bond holdings by international investors opens up for a larger depreciation of the euro. The interaction between international and domestic channels affect the magnitude and the cross-country distribution of the APP impact.

Macroeconomic Reversal Rate: Evidence from a Nonlinear IS-Curve

This paper examines the link between interest rates and expenditures, known as the IS-curve. Specifically, we analyse whether the reaction of spending behaviour to monetary policy changes is different in a low compared to a normal interest rate environment. We estimate the nonlinear IS-curve for the euro area and the five largest euro area countries over the period 1999q2-2019q1 and study whether the IS-curve relationship is regime-dependent. We employ smooth-transition local projections to estimate the impulse responses of the output gap, the growth of consumption, investment, and savings to a contractionary monetary policy shock under normal and low interest rate regimes. Our results point to a possible flattening of the IS-curve, related to substitution effects becoming weaker relative to income effects in a low interest rate regime.

Economic Policy Uncertainty in the Euro Area: An Unsupervised Machine Learning Approach

We model economic policy uncertainty (EPU) in the four largest euro area countries by applying machine learning techniques to news articles. The unsupervised machine learning algorithm used makes it possible to retrieve the individual components of overall EPU endogenously for a wide range of languages. The uncertainty indices computed from January 2000 to May 2019 capture episodes of regulatory change, trade tensions and financial stress. In an evaluation exercise, we use a structural vector autoregression model to study the relationship between different sources of uncertainty and investment in machinery and equipment as a proxy for business investment. We document strong heterogeneity and asymmetries in the relationship between investment and uncertainty across and within countries. For example, while investment in France, Italy and Spain reacts strongly to political uncertainty shocks, in Germany investment is more sensitive to trade uncertainty shocks. JEL Classification: C80, D80, E22, E66, G18, G31

Cyclical Drivers of Euro Area Consumption: What Can We Learn from Durable Goods?

We study the cyclical dynamics of consumption in the euro area (EA) and the large EA countries by distinguishing durable from nondurable expenditures. We adopt a theoretical partial equilibrium framework to justify the identification strategy of our empirical model, a time-varying parameter structural vector autoregression (TVP-SVAR). Following the main insight from the theoretical model, that liquidity constraints induce important interactions between durables and nondurables, we distinguish durable-specific demand and supply shocks, while taking into account monetary and credit conditions. Our main findings are: (i) durables react faster and more strongly than nondurables after monetary shocks in the euro area and in the largest EA countries, a confirmation of an outcome commonly reported for the US; (ii) there is a large degree of cross-country heterogeneity in how different factors (including durable-specific ones) explain consumption; (iii) the strength of spillovers from durable to nondurable consumption, as predicted by theory, is empirically correlated with how much households across countries are likely to be liquidity constrained. JEL Classification: C11, C32, D11, E21, E32

Fiscal Sustainability During the COVID-19 Pandemic

The "Great Lockdown" implemented in response to the COVID-19 pandemic has led to a severe world-wide economic crisis. In euro area countries, sovereign debt-to-GDP ratios are on the rise and reductions in expected fiscal surpluses raise sustainability concerns amongst investors. This paper provides novel estimates of non-linear state-dependent fiscal limits based on Bi (2012) for the five largest euro area countries. Within the DSGE model I build a COVID-19 scenario calibrated to match the decline in real GDP growth forecasts between April and February2020 and the fiscal stimulus packages announced up to the end of March 2020. On average, fiscal space contracts by 58.4 percent of national GDP. In a worst-case scenario fiscal space is 28.6 percent for Italy and 65.9 percent of national GDP for Germany.

Central Bank Communication and Financial Market Comovements in the Euro Area

We examine whether unscheduled communication of members of the European Central Bank’s (ECB) Governing Council affects financial market comovements. To assess comovements, we employ well-defined measures of stock market and government bond yield coexceedances, i.e., the measures of whether markets jointly decrease or increase and by how much. We use the daily data from 2008 to 2014 for the four largest euro area countries, Germany, France, Italy and Spain, in a quantile regression framework and control for persistence in coexceedances and a comprehensive set of relevant factors capturing returns and volatility in various segments of financial markets. We find that central bank communication often contributes to greater coexceedances but only when there are extreme events in the financial markets. The results also suggest that markets perceive the ECB’s communication as a euro area-wide shock, but propagation of this shock depends on the financial (in)stability of individual euro area countries.

The Bill, Please! Households’ Real Returns on Financial Assets Since the Introduction of the Euro

This paper examines the real return that households in large euro area countries achieved with their financial portfolios since the onset of the euro. A newly compiled dataset shows that, contrary to widespread belief, overall real returns did not decline in the low interest environment. Indeed with the exception of Italy, they increased on average between 2008–2017. The determinants for this development, however, differ between the countries under consideration.

Disaggregate Income and Wealth Effects in the Largest Euro Area Countries

This study extends a thick modelling tool for aggregated euro area real private consumption of de Bondt et al. (2019) to the four largest euro area countries. The suite of error correction models performs well in and out of sample. The ranges and averages of estimated elasticities are, however, sensitive to the exact model specification. We also show that decomposing disposable income into labour, property and transfer income is essential for understanding and forecasting consumption. Finally, substantial crosscountry heterogeneity in marginal propensities to consume out of income and wealth components calls for caution when interpreting aggregate euro area developments. JEL Classification: C53, D12, E21, E27

Accuracy and Determinants of Self-Assessed Euro Area House Prices

Using microdata from the second wave of the Household Finance and Consumption Survey, we investigate the accuracy of property values estimated by homeowners - so called “self-assessed” house prices - and explore the drivers of possible deviations of these prices from official hedonic house price indices. We find evidence that euro area homeowners overestimate the value of their properties by around 9%. Across the largest euro area countries, the overestimation lies in a range between 3.2% in Germany and 22% in Italy. Household characteristics, including the level of indebtedness, appear to explain significant discrepancies between hedonic and self-assessed house price indices, while the limited available data related to property characteristics are generally not affecting this gap. For the euro area, we find that higher self-assessed house prices are associated with a mild increase in consumption expenditures.

Macroprudential Policy in a Monetary Union with Cross-Border Banking

We analyse the interaction between monetary and macroprudential policies in the euro area by means of a two-country DSGE model with financial frictions and cross-border spillover effects. We calibrate the model for the four largest euro area countries (i.e. Germany, France, Italy, and Spain), with particular attention to the calibration of cross-country financial and trade linkages and country specific banking sector characteristics. We find that countercyclical macroprudential interventions are supportive of mon-etary policy conduct through the cycle. This complementarity is significantly reinforced when there are asymmetric financial cycles across the monetary union, which provides a case for targeted country-specific macroprudential policies to help alleviate the burden on monetary policy. At the same time, our findings point to the importance of taking into account cross-border spillover effects of macroprudential measures within the Monetary Union. JEL Classification: E32, E44, E52, F36, F41

On the Credit and Exchange Rate Channels of Central Bank Asset Purchases in a Monetary Union

Through the euro area crisis, financial fragmentation across jurisdictions became a prime concern for the single monetary policy. The ECB broadened the scope of its instruments and enacted a series of non-standard measures to engineer an appropriate degree of policy accommodation. The transmission of these measures through the currency union remained highly dependent on the financial structure and conditions prevailing in various regions. This paper explores the country-specific macroeconomic transmission of selected non-standard measures from the ECB using a global DSGE model with a rich financial sector: we extend the six-region multi-country model of Darracq Paries et al. (2016), introducing credit and exchange rate channels for central bank asset purchases. The portfolio rebalancing frictions are calibrated to match the sovereign yield and exchange rate responses after ECB's Asset Purchase Programme (APP) first announcement. The domestic transmission of the APP through the credit intermediation chain is significant and quite heterogeneous across the largest euro area countries. The introduction of global portfolio frictions on euro area government bond holdings by international investors opens up for a larger depreciation of the euro. The interaction between international and domestic channels affect the magnitude and the cross-country distribution of the APP impact.