Macroeconomic variables and the sovereign risk premia in EMU,non-EMU EU,and developed countries

This project studies and models key macroeconomic variables and their impact on sovereign risk premia across select European economies and developed countries. The sample is divided into three groups of countries: those in the European Monetary Union (EMU); the standalone economies outside the EMU but members of the broader European Union (EU); and other developed economies. The main subject of examination across all three groups is the impact of macroeconomic variables on sovereign borrowing costs. EU countries have experienced high financial stress and a rapid rise in the credit default swaps (CDS) spreads during the EMU debt crisis. A nonlinear vector smooth transition autoregressive model is applied to investigate such a regime change in the finance-output link using sovereign CDS and industrial production index. The paper finds that regime-switching takes place rather suddenly in most EMU countries. The study concludes that due to the potential spillover effects in the EU as a whole, the individual country macroeconomic indicators were less reflected in the financial stress and spillover and contagion effects became dominant.     

Multiple Wage Bargaining Systems in the Single European Currency Area

Little attention in the EMU literature has been paid to the interaction between centralbank monetary rules and systems of collective wage bargaining. Analytically andempirically, coordinated wage bargaining systems respond with real wage restraintto non-accommodating monetary policy. Since wage determination is dominated bycollective bargaining in all the EMU member states and wage coordination within themember states has grown since 1980, this is a topic of potential importance. In particular, the replacement of the Bundesbank, directly targeting German inflation, by an ECB targeting European inflation has removed a major institutional support of wage restraint in Germany. The consequences of this for EMU are worked out under two scenarios, that inflation expectations will be generated by ECB monetary policy and that they will reflect German inflation outcomes. Possible institutional developments are discussed including government-union bargains. The Bundesbank has also played a major role in maintaining fiscal rectitude by targeting excess fiscal deficits in Germany: again its replacement by the ECB – targeting (if at all) European rather than German fiscal policy – loosens fiscal constraints. For underlying structural reasons therefore, it is possible that Germany and other EMU countries will move to a period of fiscal activism with wage restraint and low inflation purchased through social contract negotiations.     

Monetary policy through the ‘credit-cost channel’: Italy and Germany pre- and post-EMU

We present an empirical analysis of the ‘Credit-Cost Channel’ (CCC) of monetary policy transmission. This channel combines bank credit supply and interest rates on loans as a cost to firms. The thrust of the CCC is that it makes both aggregate demand and aggregate supply dependent on monetary policy. As a consequence (1) credit market conditions (e.g. risk spreads) are important sources and indicators of macroeconomic shocks, (2) the real effects of monetary policy are larger and persistent. We have applied the Cointegrated Vector Autoregression (CVAR) econometric methodology to Italy and Germany in the ‘hard’ EMS period and in the European Monetary Union (EMU) period. The short-run and long-run effects of the CCC are detectable for both countries in both periods. Simulation of the estimated model also confirms that inflation-targeting by way of inter-bank rate control stabilizes inflation through structural shifts of the stochastic equilibrium paths of both inflation and the output.     

Price convergence in the EMU? Evidence from micro data

The establishment of the European Monetary Union (EMU) was widely expected to cause price convergence among member states. In an investigation of this claim, the present study avoids problems of comparability and representativeness by using an extremely detailed and comprehensive scanner database on washing machine prices and sales volumes for 17 European countries. A hedonic regression yields country-specific time series for quality-adjusted price differentials. Statistically and economically significant deviations from the Law of One Price emerge. Log t tests firmly reject price convergence among EMU countries. Small convergence clusters can be identified but they are unrelated to EMU membership.     

Dynamic relationship between Turkey and European countries during the global financial crisis

This study examines the relationship between time-varying risk perceptions of investors towards major European countries and Turkey. In that manner, we first obtain the dynamic conditional correlations between the credit default spreads (CDSs) of Turkey and 13 European countries from September 2004 to April 2013. Next, we endogenously detect the shifts in these dynamic correlation levels using a penalized contrast methodology. Accordingly, we find positive level shifts in all correlations following the US crisis. The upward trend in all CDS correlations holds during the eurozone debt crisis, but positive changes in correlations are not flagged as level shifts by the model, except in a few cases. The results suggest that Turkey is not immune to global financial conditions and there is integration between Turkey and the major European economies in terms of risk perception after the global financial crisis.     

The bank lending channel of monetary policy in EU countries during the global financial crisis

The study examines the existence of the bank lending channel of monetary policy in European Union (EU) countries. The paper advances current research on the monetary transmission mechanism in the following ways: Firstly, we analyze the differences between ‘old’ Economic Monetary Union (EMU) and ‘new’ EU countries. Secondly, we examine the key bank characteristics and monetary policy indicators that may have an impact on the bank lending channel. We assume that short-term market interest rates and monetary aggregate M2 affect banks' activities. We apply the generalized method of moments (GMM) with pooled data from 1999 to 2012. We show that in the pre-crisis period the effect of changing the short-term market interest rates on the bank lending channel of monetary policy is more pronounced among ‘old’ EMU countries, whereas the effect of M2 is significant during the period of the global financial crisis (GFC) among ‘old’ EMU countries. Last but not least the important finding is that banks in ‘new’ EU countries react differently to monetary shocks.     

Monetary policy implementation and transmission in the European Monetary Union

I discuss possible problems engendered by loss of national monetary policies, and study them from three empirical perspectives. First, are business cycles sufficiently synchronized across EMU member countries? The evidence suggests that economic activity in those countries has become increasingly correlated in the 1990s, and that policy co–ordination has played a role in generating that outcome. Second, are there asymmetries in the mechanisms through which policy affects economic activity? The paper documents that policy transmission was indeed heterogeneous in the member countries, and that structural and financial factors were sensibly related to cross–country differences in the response of output to a monetary policy shock. Third, how is policy implemented in an environment of diverse business cycle fundamentals and transmission mechanisms? Estimation of monetary policy reaction functions finds that the European Central Bank is closer to an aggregate of the central banks in Germany, France, and Italy than to the Bundesbank alone.     

The political economy under monetary union: has the euro made a difference?

Economic and monetary union (EMU) has transformed Europe and has created an integrated pan-European economy. Much research has focused on understanding this integration process and what benefits and costs it entails. This paper identifies a political economy channel of EMU as the monetary union implies that member states had to transfer or at least curtail their policy autonomy in several areas, such as monetary policy and fiscal policy. The paper shows that EMU has helped reduce the impact of political shocks on the domestic economy of member states but magnified the transmission of political shocks within the euro area. Equally importantly, economies with weak domestic policies and institutions exhibited a significantly higher sensitivity to domestic political shocks before EMU, but not thereafter. While this may entail that EMU has brought benefits to countries with weaker policies and institutions by insulating them from adverse political developments at home, a potential drawback is that it may provide weaker market discipline for domestic political stability.
— Marcel Fratzscher and Livio Stracca     

Risk sharing through capital gains

Abstract We estimate channels of international risk sharing between European Monetary Union (EMU), European Union, and other OECD countries, 1992–2007. We focus on risk sharing through savings, factor income flows, and capital gains. Risk sharing through factor income and capital gains was close to zero before 1999 but has increased since then. Risk sharing from capital gains, at about 6%, is higher than risk sharing from factor income flows for European Union countries and OECD countries. Risk sharing from factor income flows is higher for euro zone countries, at 14%, reflecting increased international asset and liability holdings in the euro area.     

Global banking,global crises? The role of the bank balance-sheet channel for the transmission of financial crises

We examine whether shocks to leveraged creditors with cross border holdings have an incidence on debtor countries׳ risk of suffering financial turmoil. We construct a new proxy of shocks to international banks׳ balance-sheets using credit ratings and the structure of their international assets. This allows us investigating the effect of (foreign) bank balance-sheet shocks on domestic financial turmoil in a large sample of 146 developed and emerging economies from 1984 to 2011. Our proxies of shocks towards bank balance-sheets are strong predictors of systemic banking crises in their debtor countries. Confirming these results, bilateral bank flows significantly decrease when creditor banks׳ assets are hit by negative shocks, as measured by credit rating downgrades from third-party countries. Short-term liabilities towards global banks appear to increase roll-over and funding risks, thereby amplifying the impact of shocks to foreign lenders’ balance-sheets. Domestic banking sectors vulnerabilities, such as illiquid assets and a low deposit-asset ratio, are found to increase crisis contagion risk. In contrast, a high level of global liquidity attenuates the transmission of shocks to international banks׳ assets to debtor countries.     

Business Cycle Synchronization in Europe: Evidence from a Dynamic Factor Model

This paper revisits the effect of the European Economic and Monetary Union (EMU) on the extent of business cycle synchronization across its member states. A dynamic latent factor model is used to identify the ‘regional’ effect of the euro area on output growth and inflation dynamics across European countries. The results of variance decomposition analysis confirm that both output growth and inflation tended to be more synchronized among European countries during the run-up to the EMU, but there is no strong evidence to support the argument that the ‘regional’ effects prevailed after 1999.     

Mortgage Credit: Denmark’s Financial Capacity Building Regime

ABSTRACT

The integration of small states into the international financial system has constrained their ability to enact the traditional macroeconomic tools of fiscal and monetary policy. As systems of mortgage credit are tightly integrated into global capital markets and influence flows of capital between states, this paper uses Denmark as a case study to explore whether domestic mortgage sector reforms have been used to build financial capacity to compensate for the loss of economic policy autonomy. The results of this analysis suggest that the Danish government has actively used mortgage credit to meet three specific macroeconomic objectives since the 1980s: (1) mortgage credit was restricted in the 1980s to resolve Denmark's persistent balance of payments problem; (2) liberalisations of mortgage credit in the 1990s and 2000s allowed the Danish government to stimulate the economy via privatised/house-price Keynesianism and reduce their sovereign debt burden; and (3) mortgage credit has been used as a form of privatised monetary policy, allowing Denmark to break-free from the ‘iron-cage’ of the Mundell-Fleming trilemma. It is in these specific ways that the Danish government has used mortgage reforms to achieve macroeconomic policy autonomy and navigate economic challenges whilst adhering to the constraints of the international financial system.     

Monetary integration,soft budget constraints,and the EMU sovereign debt crises

One possible explanation for the European sovereign debt crises is that the European Economic and Monetary Union (EMU) gave rise to consolidation fatigue or even deliberate over‐borrowing. This paper explores the validity of this explanation by studying how three decisive stages in the history of the EMU affected public borrowing in EU member states: the signing of the Maastricht Treaty, the introduction of the Euro, and the suspension of the Stability and Growth Pact (SGP). The methodology relies on difference‐in‐difference regressions for 26 OECD countries over the 1975–2009 period. The findings indicate that the Maastricht treaty reduced deficits especially in traditionally high‐deficit countries. In contrast, the introduction of the Euro and the watering down of the original SGP led on average to higher borrowing. These results indicate that the introduction of the Euro and the suspension of the SGP led to soft budget constraints in the EMU.     

Welfare implications of strategic economic policy in eastern Europe

This paper evaluates the welfare effects in a block of selected eastern European countries (Bulgaria, Romania, former Czechoslovakia, Hungary, Poland, and former Yugoslavia) emerging from the possibility to participate in the European integration process and to act as strategic players in dynamic games. The results of the cooperative and noncooperative dynamic game scenarios are compared with fixed policy solutions. The McKibbin-Sachs global model (MSG2 model), which incorporates rational expectations, is used as a framework. A global supply-side shock and a fixed exchange rate regime are considered under the alternative policy layouts. It is shown that international economic cooperation may be advantageous over noncooperation. For the anchor currency of the European Monetary Union (EMU), fixing the eastern European block currencies to the EMU may lead to significant destabilization.     

Monetary policy co-movement and spillover of shocks among BRICS economies

The 2008 global financial crisis has revealed the possibility of cross-border spillover effects of domestic Monetary Policy (MP) on financial stability and capital flows around the world. Recognizing these facts, Central Banks in Advanced Economies (AE) have undertaken simultaneous Monetary Policy actions to minimize collateral damage and contain financial risks. In this paper, we investigate whether a similar spillover and co-movement of Monetary Policy exist among BRICS countries. Specifically, we study the transmission of monetary policy shocks among the member countries using monthly data. We use the method of Principal Component Analysis (PCA) and Vector Autoregression Model to identify possible dynamic relationships. Our results indicate possible co-movement in interest rates and significant cross-border transmission of monetary policy shocks among the BRICS countries.     

Has the 2008 financial crisis and its aftermath changed the impact of inflation on inflation uncertainty in member states of the european monetary union?

We study to what extent the financial crisis of 2008 and its aftermath have changed the impact of inflation on inflation uncertainty in the 12 original member states of the European Monetary Union (EMU). We adopt a time‐varying coefficient regression model with stochastic volatility effects, and extract two measures of inflation uncertainty from our data, namely, (1) The conditional volatility of inflation, (2) The conditional volatility of steady‐state inflation. (1)–(2) represent short‐run and steady‐state inflation uncertainty, respectively. The time‐varying impact of inflation on inflation uncertainty is analyzed using Markov‐switching regressions, where switching between the low and high inflation uncertainty regime is determined via an unobserved Markov process. Results suggest that the 2008 financial crisis and its aftermath have changed the impact of inflation on (1) and (2) across the selected EMU member states. However, a uniform pattern cannot be detected. For some member states, we document a strong link, whereas for others, the impact of inflation on inflation uncertainty is relatively weaker.     

Estimating the effect of the EMU on current account balances: A synthetic control approach

The European sovereign debt crisis wrought major political and economic damage on the European Monetary Union (EMU). This led to a reassessment of the pre-crisis period of economic growth and stability in the EMU, shifting attention to the macroeconomic imbalances that emerged between member states, especially those in current account balances. This paper uses macroeconomic data on OECD economies and a new statistical approach for causal inference in observational studies—the synthetic control method—to estimate the effect of the EMU on the current account balances of individual member states. This ‘counterfactuals’ approach provides strong evidence that the introduction of the EMU was responsible for the divergence in current account balances among member states in the run-up to the euro crisis. The results suggest that the EMU effect operated through multiple channels and that fundamental changes to the institutional framework of the EMU may be required to safeguard the currency union against a reemergence of dangerous external imbalances in the future.     

Trade creation,trade diversion and imbalances in the EMU

The aim of this paper is to provide a unified explanation for the mixed evidence on the euro effect on trade and the development of imbalances in the European Monetary Union (EMU). It is argued that the two phenomena are the result of trade creation and trade diversion effects generated by the euro introduction and by globalisation-induced changes in trade patterns. Trade creation and trade diversion effects are estimated as structural changes in the relation between trade flows and financial opening, growth, prices, and measures of globalization. While most of these effects point to the increase in imbalances, financial opening is found to positively affect intra-EMU trade. On the other hand, GDP growth and global changes in production technology reduced intra-EMU trade. The results suggest that policies aimed at rebalancing the EMU should be strengthened and supported by measures aimed at improving the competitiveness of the single market as a whole.     

Macroeconomic determinants of the credit risk in the banking system: The case of the GIPSI

In this paper, we analyze the link between the macroeconomic developments and the banking credit risk in a particular group of countries – Greece, Ireland, Portugal, Spain and Italy (GIPSI) – recently affected by unfavourable economic and financial conditions.Employing dynamic panel data approaches to these five countries over the period 1997q1–2011q3, we conclude that the banking credit risk is significantly affected by the macroeconomic environment: the credit risk increases when GDP growth and the share and housing price indices decrease and rises when the unemployment rate, interest rate, and credit growth increase; it is also positively affected by an appreciation of the real exchange rate; moreover, we observe a substantial increase in the credit risk during the recent financial crisis period. Several robustness tests with different estimators have also confirmed these results.The findings of this paper indicate that all policy measures that can be implemented to promote growth, employment, productivity and competitiveness and to reduce external and public debt in these countries are fundamental to stabilize their economies.     

Financial Crisis and its Asymmetric Macroeconomic Impact on Eurozone Member Countries

The purpose of the paper is to analyze the dynamics of EMU (The Economic and Monetary Union, i.e., the group of European countries who use the common currency euro) and to analyze the fallout from the recent financial and economic dynamics. Both the impact on the eurozone as a whole and on individual member countries will be evaluated. The first 11 years of Eurozone experience will be discussed and evaluated in the second section. The third section will then be devoted to analyzing the fallout from the recent financial and economic dynamics. Both the impact on the eurozone as a whole and on individual member countries will be evaluated. The last section concludes and provides some ideas for future development of eurozone.