EU Enlargement and Trade Integration: Lessons from a Gravity Model

The authors estimate gravity models using a large panel of bilateral trade flows across 61 countries between 1980 and 2003, which are applied as a benchmark for the integration of Central and South Eastern European countries with the euro area. They show that a careful examination of the fixed effects of the model is crucial for the proper interpretation of the results. The results suggest that trade integration between most new EU member states and the euro area is already relatively advanced, while the remaining Central and Eastern European countries have significant scope to strengthen trade links with the euro area.     

The EAGLE. A model for policy analysis of macroeconomic interdependence in the euro area

We develop a 4-region macroeconomic model of the euro area and the world economy. The model (EAGLE, Euro Area and Global Economy model) is microfounded and designed for conducting quantitative policy analysis of macroeconomic interdependence across regions in the euro area and between the euro area and the world economy. Specifically, we simulate a permanent reduction in labor tax rates in the euro area. The effects on real activity are expansionary in both the short run and long run. Implementing reforms simultaneously across regions would produce extra benefits and make the macroeconomic performance in the euro area more even.     

Enlargement and the Value of the Euro

The EMU is in the process of expanding its membership. How will the expansion affect the equilibrium or sustainable real value of the euro? What is the explanatory power of the model used to explain the equilibrium value of a synthetic euro? We then demonstrate quantitatively the dynamic effects of enlargement upon the equilibrium value of the euro under different scenarios.     

Firm credit in the euro area: a tale of three crises

Using survey data from 2009 to 2011, we analyse the effects of the recent euro area economic, financial and private debt crisis on the supply of and demand for bank finance for small and medium enterprises (SMEs). At the country level, we identify three distinct aspects of the recent crisis in the euro area affecting firm credit through different channels. Controlling for country fixed effects, the impact of a weak real economy on firm credit operates both by reducing firms’ demand for bank financing and by lenders increasing loan rejections and tightening terms and conditions on credit allocated. On the other hand, financial conditions have no significant effect on demand, but they do affect credit supply as we find that financial tensions worsen the chances of obtaining credit and its terms and conditions. We interpret this as evidence of a bank balance sheet channel negatively impacting credit provision. We find that private sector indebtedness has important effects on SMEs’ credit access and its terms and conditions.     

Fiscal consolidation in the euro area: Long-run benefits and short-run costs

In this paper, we examine the macroeconomic effects of alternative fiscal consolidation policies in the New Area-Wide Model (NAWM), a two-country open-economy model of the euro area developed at the European Central Bank (cf. [Coenen, G., McAdam, P., Straub, R., in press. Tax reform and labour-market performance in the euro area: a simulation-based analysis using the New Area-Wide Model. Forthcoming in the Journal of Economic Dynamics and Control]). We model fiscal consolidation as a permanent reduction in the targeted government debt-to-output ratio and analyse both expenditure and revenue-based policies that are implemented by means of simple fiscal feedback rules. We find that fiscal consolidation has positive long-run effects on key macroeconomic aggregates such as output and consumption, notably when the resulting improvement in the budgetary position is used to lower distortionary taxes. At the same time, fiscal consolidation gives rise to noticeable short-run adjustment costs in contrast to what the literature on expansionary fiscal consolidations suggests. Moreover, depending on the fiscal instrument used, fiscal consolidation may have pronounced distributional effects.     

THE TRANSMISSION OF THE MONETARY POLICY IN THE EURO AREA: THE ROLE OF THE BANKS’ BUSINESS MODEL

This paper sheds some new light on the incidence of the banks’ business model as a component of the bank lending channel in the euro area. Differently from existing literature, the analysis is led on the basis of the two main macroeconomic regions that today characterize the euro area: its north‐east (German‐centric) and south‐west halves. The observation period is 2008–2013, mainly featured by the financial and economic crisis. The empirical findings evidence that in the north‐east half of the euro area the cooperative banks leveraged the effects of the reduction in the interest rates in terms of new lending. In this respect, they differentiated from commercial and savings banks, which showed a more neutral impact on the transmission of the monetary policy decisions. These results highlight the distinctive role of the cooperative banks in terms of credit provision in Germany and in the whole north‐east half of the euro area. Nevertheless, this cooperative banking effect did not emerge for the south‐west half of the continent, particularly hit by the crisis. This may suggest that the bank's business model tend to be neutral to the transmission of the monetary policy in economies characterized by prolonged recessions.     

Portfolio choice of financial investors and European business cycle convergence: a panel analysis for EU countries

We investigate the linkage between business cycle convergence and financial portfolio choice for a panel of 18 EU countries. We construct an index of similarity of financial portfolios which we then put into context with the view that “the financial world” has an impact on business cycles and contributes to business cycle convergence via the consumption-wealth linkage. The model which guides our analysis is the International Asset Pricing Model (IAPM). Portfolios of the 18 EU countries investigated by us turn out to become more similar over time. According to our fixed effects GMM TSLS estimations, similar portfolios contribute to a convergence of business cycles—via a convergence of consumption cycles. This turns out to be especially true for country-pairs that include euro area non-member countries and, thus, have quite different income and wealth structures.     

The reliability of real-time estimates of the euro area output gap

This paper provides evidence on the reliability of euro area real-time output gap estimates. A genuine real-time data set for the euro area is used, including vintages of several sets of euro area output gap estimates available from 1999 to 2010. It turns out that real-time estimates of the output gap tend to be characterised by a high degree of uncertainty, much higher than that resulting from model and estimation uncertainty only. In particular, the evidence indicates that both the magnitude and the sign of the real-time estimates of the euro area output gap are very uncertain. The uncertainty is mostly due to parameter instability and model uncertainty, while data revisions seem to play a minor role. Some euro area real-time measures, based on multivariate components models and capacity utilisation, are relatively less uncertain, but do not appear to be fully reliable along some dimensions. To benchmark our results, we repeat the analysis for the US over the same sample. It turns out that US real-time estimates tend to be revised to a lesser extent than euro area estimates. However, euro area real-time output gap estimates tend to display a higher correlation with the final estimates and the sign of the level of US real-time estimates tends to be revised more often compared to the corresponding euro area estimates. In addition, the data revision component of the revision error is larger for US estimates than for the euro area. Overall, the unreliability in real-time of the US output gap measures detected in earlier studies is confirmed in the more recent period.     

On the Empirical Evidence of the Intertemporal Current Account Model for the Euro Area Countries

A simple intertemporal current account model is found to explain successfully the current account configuration in the euro area before the Great Recession. The analysis suggests that consumption smoothing, prompted by expectations of economic convergence and the removal of exchange rate risk, has been an important driving force for the build‐up of current account divergence in the euro area since the creation of monetary union. The model also predicts that current account deficits and surpluses would narrow under a post‐crisis scenario of moderate catching‐up and more segmented bond markets.     

Examining asymmetries in the transmission of monetary policy in the euro area: Evidence from a mixed cross-section global VAR model

I estimate the transmission of a common euro area monetary policy shock across individual euro area economies. To do so, I develop a global VAR model in which all euro area economies are included individually while, at the same time, their common monetary policy is modelled as a function of euro area aggregate output growth and inflation. The results suggest that the transmission of monetary policy across euro area economies displays asymmetries, and that, in line with economic theory, these are driven by differences in economies׳ structural characteristics. In particular, euro area economies in which a higher share of aggregate output is accounted for by sectors servicing interest rate sensitive demand exhibit a stronger transmission of monetary policy to real activity. Similarly, even though the evidence is less conclusive, euro area economies which feature more real wage and/or fewer unemployment rigidities also appear to display a stronger transmission of monetary policy to real activity.     

Trade implications of the Euro in EMU countries: a panel gravity analysis

In this paper, we study the intra-EMU and intra-Eurozone trade effects of the euro adoption on 29 European Economic and Monetary Union countries (including 17 Eurozone economies and Iceland) from the period 1994 through 2011. We employ a generalized gravity model that controls for an extended set of trade theory and policy variables. The gravity model is estimated using the robust panel data techniques that includes times effects, besides country-specific effects. The various econometric specifications of the gravity equation, on the whole dataset of 29 economies, yield positive and significant impact (to be around 14 %) of the euro currency adoption on bilateral trade flows. Next, euro effect on bilateral trade and exports on a smaller dataset is estimated. The estimated results suggest that bilateral trade and exports increase by 20.81 and 18.57 %, respectively, when both the countries belong to the Eurozone. This effect is larger than the one obtained when only one of the two trading partners uses the euro as its currency. In addition, the validity of the assumptions of Heckscher–Ohlin (H–O) theory are checked for the countries under study. The estimated results reject the H–O theory in favor of Modern Trade theories. However, the low value of the coefficient on respective variable suggests that, over the period, the type of trade among these countries has transited from inter-industry trade to horizontal intra-industry trade. This suggests that these developed European economies are on the path of economic convergence via intra-industry trade.     

The effect of the euro on foreign direct investment

In this paper the recent effect of the European Monetary Union on inward FDI-flows is examined using a difference-in-differences approach. The estimated results show that the introduction of the euro raised inward FDI flows by approximately 16% within the euro area, by approximately 11% to non-members and weakly by around 8% from non-member countries into the euro area. Moreover, the geographical effects of the euro are explored. The results show partial agglomeration tendencies for the euro area. There are also some indications of increased importance of vertical specialization in the sample.     

Market efficiency and the Euro: the case of the Athens stock exchange

The behaviour of an emerging market, the Athens Stock Exchange, after the introduction of the euro is investigated. The latter would make its returns easier to compare; reduce uncertainty; eliminate the exchange rate risk and as a result we expect the new currency to strengthen the argument, in favour of the EMH. The General ASE Composite Index and the FTSE/ASE 20, which consists of “high capitalisation” companies, are used. Five statistical tests are employed to test the residuals of the random walk model: the BDS, McLeod-Li, Engle LM, Tsay and Bicovariance test. Bootstrap and asymptotic values of these tests are estimated. Alternative models from the GARCH family (GARCH, EGARCH and TGARCH) are also presented in order to investigate the behaviour of the series. Lastly, linear, asymmetric and non-linear error correction models are estimated and compared. The preferred model (TGARCH) suggests that leverage effects are present and the news impact curve is asymmetric.     

Estimating the effects of coordinated fiscal actions in the euro area

We estimate spillover effects of a fiscal shock in one member country in the euro area on outputs of the rest of the members, using a global vector autoregression (GVAR) model. We compare the effects of a domestic fiscal shock with those of a similar size area-wide shock expressed as a weighted average of the fiscal shocks across all member countries. According to our estimates, the impact of an area-wide fiscal shock on output of a member country tends to be positive and larger than that of a domestic shock. Since the cost of participating in the area-wide shock is lower than the cost of a similar size domestic shock, our finding indicates the importance of coordinated fiscal actions in the euro area.     

Financial market frictions in a model of the Euro area

We build a model of the euro area incorporating financial market frictions at the level of firms and households. Entrepreneurs borrow from financial intermediaries in order to purchase business capital, in the spirit of the “financial accelerator” literature. We also introduce two types of households that differ in their degree of time preference. All households have preferences for housing services. The impatient households are faced with a collateral constraint that is a function of the value of their housing stock. Our aim is to provide a unified framework for policy analysis that emphasises financial market frictions alongside the more traditional model channels. The model is estimated by Bayesian methods using euro area aggregate data and model properties are illustrated with simulation and conditional variance and historical shock decomposition.     

Behavioural equilibrium exchange rate and total misalignment: evidence from the euro exchange rate

In the present paper we attempt to investigate whether the nominal exchange rate of the euro against the currencies of the four major trading partners of the eurozone, namely China, Japan, the UK and the USA, converges or not to its equilibrium level. Applying recent unit root and system cointegration techniques in the presence of structural shifts in the data, our results indicate that there exist an equilibrium relationship between each of the euro/yuan, euro/yen, euro/UK pound and euro/US dollar nominal exchange rates and the fundamentals defined by the monetary model. Following these results, our modified Behavioural Equilibrium Exchange Rate model suggests that at the end of the estimated period, the euro/Chinese yuan and the euro/UK pound nominal exchange rates follow an equilibrium process. Our empirical results also imply that the single European currency is considered as overvalued against the US dollar, while it is considered as undervalued against the Japanese currency.     

The impact of foreign macroeconomic news on financial markets in the Czech Republic, Hungary, and Poland

In this paper, we investigate the effects of euro area and US macroeconomic news on financial markets in the Czech Republic, Hungary, and Poland (CEEC-3) from 1999 to 2006. Using a GARCH model, we examine the impact of news on daily returns of 3-month interest rates, stock market indices, exchange rates versus the euro, and the US dollar. First, both US and European macroeconomic news has a significant impact on CEEC-3 financial markets. Second, the process of European integration is accompanied by an increasing importance of euro area news relative to US news. Third, there are country-specific differences: for example, the Czech stock market is relatively more affected by foreign news since the Copenhagen Summit in December 2002. In general, our results support the hypothesis of a deepening euro area influence on the CEEC-3 over time and a corresponding reduction in the relative importance of US shocks.     

Explaining the early years of the euro exchange rate: An episode of learning about a new central bank

Many observers were surprised by the depreciation of the euro after its launch in 1999. Handicapped by a short sample, explanations tended to appeal to anecdotes and lessons learned from the experiences of other currencies. Now sample sizes are just becoming large enough to permit reasonable empirical analyses. The model of this paper provides empirical support for the euro exchange rate to be affected by learning. By focusing on euro-area inflation as the key fundamental, the model is structured toward the dynamics of learning about ECB policy with regard to inflation. While a stated target inflation rate of 2 percent existed, it may be that market participants had to be convinced that the ECB would, indeed, generate low and stable inflation. With a prior distribution drawn from the pre-euro EMS experience and updating based upon the realized experience each month following the introduction of the euro, the evidence suggests that it was not until December of 1999 that the market assessed a greater than 50 percent probability that the inflation process had changed to a new regime. From this point on, trend depreciation of the euro ends and further increases in the probability of the new inflation process are associated with euro appreciation versus the US dollar, the British pound and the Japanese yen.     

An analysis of the determinants of job satisfaction when individuals’ baseline satisfaction levels may differ

A growing literature seeks to explain differences in individuals’ self-reported satisfaction with their jobs. The evidence so far has mainly been based on cross-sectional data and when panel data have been used, individual unobserved heterogeneity has been modelled as an ordered probit model with random effects. This article makes use of longitudinal data for Denmark, taken from the waves 1995–1999 of the European Community Household Panel, and estimates fixed effects ordered logit models using the estimation methods proposed by Ferrer-i-Carbonel and Frijters (2004) and Das and van Soest (1999). For comparison and testing purposes a random effects ordered probit is also estimated. Estimations are carried out separately on the samples of men and women for individuals’ overall satisfaction with the jobs they hold. We find that using the fixed effects approach (that clearly rejects the random effects specification), considerably reduces the number of key explanatory variables. The impact of central economic factors is the same as in previous studies, though. Moreover, the determinants of job satisfaction differ considerably between the genders, in particular once individual fixed effects are allowed for.     

Financial sector and output dynamics in the euro area: Non-linearities reconsidered

We analyze the feedback mechanisms between economic downturns and financial stress for several euro area countries. Our study employs newly constructed financial condition indices that incorporate banking variables extensively. We apply a non-linear Logistic Vector Smooth Transition Autoregressive (LVSTAR) model for investigating instabilities in the link between the financial sector and economic activity. The LVSTAR model allows for non-linear dynamics and regime changes between low and high stress regimes. It can also replicate the regime-specific amplification effects shown by our theoretical model. The amplification effects, however, change over time. Specifically after the Lehman collapse, we observe the presence of strong non-linearities and amplification mechanisms for some euro area countries. Thus, these strong amplification effects appear to be related to rare but large events, and to a low-frequency financial cycle. Prior to the financial crisis outbreak we find corridor stability even if the financial sector shock takes place in a high stress regime. More important seems to be the shock propagation over time in the economy. Only with the occurrence of rare but large events we find strong endogenous feedback loops and a loss of stability as described by the high stress regime of our theoretical model. The economy leaves the corridor of stability and is prone to adverse feedback loops.