Working papers

In-depth studies for experts

Our Working Paper Series (WPS) disseminates economic research relevant to the various tasks and functions of the ECB, and provides a conceptual and empirical basis for policy-making. The Working Papers constitute “work in progress”. They are published to stimulate discussion and contribute to the advancement of our knowledge of economic matters. They are addressed to experts, so readers should be knowledgeable in economics.

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No. 2309
16 August 2019
Much ado about nothing? The shale oil revolution and the global supply curve

Abstract

JEL Classification

Q33 : Agricultural and Natural Resource Economics, Environmental and Ecological Economics→Nonrenewable Resources and Conservation→Resource Booms

Q41 : Agricultural and Natural Resource Economics, Environmental and Ecological Economics→Energy→Demand and Supply, Prices

Q43 : Agricultural and Natural Resource Economics, Environmental and Ecological Economics→Energy→Energy and the Macroeconomy

C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes

Abstract

We focus on the implications of the shale oil boom for the global supply of oil. We begin with a stylized model with two producers, one facing low production costs and one higher production costs but potentially lower adjustment costs, competing à la Stackelberg. We find that the supply function is flatter for the high cost producer, and that the supply function for shale oil producers becomes more responsive to demand shocks when adjustment costs decline. On the empirical side, we apply an instrumental variable approach using estimates of demand-driven oil price changes derived from a standard structural VAR of the oil market. A main finding is that global oil supply is rather vertical, practically all the time. Moreover, for the global oil market as a whole, we do not find evidence of a major shift to a more price elastic supply as a result of the shale oil boom.

No. 2308
14 August 2019
Dominant-currency pricing and the global output spillovers from US dollar appreciation

Abstract

JEL Classification

F42 : International Economics→Macroeconomic Aspects of International Trade and Finance→International Policy Coordination and Transmission

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

C50 : Mathematical and Quantitative Methods→Econometric Modeling→General

Abstract

Different export-pricing currency paradigms have different implications for a host of issues that are critical for policymakers such as business cycle co-movement, optimal monetary policy, optimum currency areas and international monetary policy co-ordination. Unfortunately, the literature has not reached a consensus on which pricing paradigm best describes the data. Against this background, we test for the empirical relevance of dominant-currency pricing (DCP). Specifically, we first set up a structural three-country New Keynesian dynamic stochastic general equilibrium model which nests DCP, producer-currency pricing (PCP) and local-currency pricing (LCP). In the model, under DCP the output spillovers from shocks that appreciate the US dollar multilaterally decline with an economy’s export-import US dollar pricing share differential, i.e. the difference between the share of an economy’s exports and imports that are priced in the dominant currency. Underlying this prediction is a change in an economy’s net exports in response to multilateral changes in the US dollar exchange rate that arises because of differences in the extent to which exports and imports are priced in the dominant currency. We then confront this prediction of DCP with the data in a sample of up to 46 advanced and emerging market economies for the time period from 1995 to 2018. Specifically, controlling for other cross-border transmission channels, we document that consistent with the prediction from DCP the output spillovers from US dollar appreciation correlate negatively with recipient economies’ export-import US dollar invoicing share differentials. We document that these findings are robust to considering US demand, US monetary policy and exogenous exchange rate shocks as a trigger of US dollar appreciation, as well as to accounting for the role of commodity trade in US dollar invoicing.

No. 2307
14 August 2019
Estimation of impulse response functions when shocks are observed at a higher frequency than outcome variables

Abstract

JEL Classification

C22 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models &bull Diffusion Processes

Abstract

This paper proposes mixed-frequency distributed-lag (MFDL) estimators of impulse response functions (IRFs) in a setup where (i) the shock of interest is observed, (ii) the impact variable of interest is observed at a lower frequency (as a temporally aggregated or sequentially sampled variable), (iii) the data generating process (DGP) is given by a VAR model at the frequency of the shock, and (iv) the full set of relevant endogenous variables entering the DGP is unknown or unobserved. Consistency and asymptotic normality of the proposed MFDL estimators is established, and their small-sample performance is documented by a set of Monte Carlo experiments. The proposed approach is then applied to estimate the daily pass-through of changes in crude oil prices observed at the daily frequency to U.S. gasoline consumer prices observed at the weekly frequency. We find that the pass-through is fast, with about 23% of the crude oil price changes passed through to retail gasoline prices within five working days, representing about 42% of the long-run pass-through.

No. 2306
12 August 2019
A macroeconomic vulnerability model for the euro area

Abstract

JEL Classification

E37 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Forecasting and Simulation: Models and Applications

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

F47 : International Economics→Macroeconomic Aspects of International Trade and Finance→Forecasting and Simulation: Models and Applications

O52 : Economic Development, Technological Change, and Growth→Economywide Country Studies→Europe

Abstract

Macroeconomic imbalances increase the vulnerability of an economy to adverse shocks, which in turn can lead to crises with severe economic and social costs. We propose an early warning model that predicts such crises. We identify a set of macroeconomic indicators capturing domestic and external imbalances that jointly predict severe recessions (i.e. growth crises) in a multivariate discrete choice framework. The approach allows us to quantify an economy's macroeconomic vulnerabilities at any point in time. In particular, the model would have pointed early on to emerging vulnerabilities in all the euro area countries that registered severe recessions in the years after 2007. We also show that the model can be applied beyond the euro area crisis in that its main results remain robust to changes in assumptions and sample composition.

No. 2305
1 August 2019
The cost-efficiency and productivity growth of euro area banks

Abstract

JEL Classification

C23 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Panel Data Models, Spatio-temporal Models

D24 : Microeconomics→Production and Organizations→Production, Cost, Capital, Capital, Total Factor, and Multifactor Productivity, Capacity

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

We use an industrial organisation approach to quantify the size of Total Factor Productivity Growth (TFPG) for euro area banks after the crisis and decompose it into its main driving factors. In addition, we disentangle permanent and time-varying inefficiency in the banking sector. This is important because lack of distinction may lead to biased estimates of inefficiency and because the set of policies needed in both cases is different. We focus on 17 euro area countries over the period 2006 to 2017. We find that cost efficiency in the euro area banking sector amounted to around 84% on average over the 2006 to 2017 period. In addition, we observe that Total Factor Productivity growth for the median euro area bank decreased from around 2% in 2007 to around 1% in 2017, with technological progress being the largest contributor, followed by technical efficiency. Given the need to boost productivity and enhance profitability in the euro area banking sector, these findings suggests that bank’s efforts in areas such as rationalisation of branches, digitalisation of business processes and possibly mergers and acquisitions should be intensified.

No. 2304
1 August 2019
Expectations-driven liquidity traps: implications for monetary and fiscal policy

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination

E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy

Abstract

We study optimal monetary and fiscal policy in a New Keynesian model where occasional declines in agents’ confidence can give rise to persistent liquidity trap episodes. Unlike in the case of fundamental-driven liquidity traps, there is no straightforward recipe for mitigating the welfare costs and the systematic inflation shortfall associated with expectations-driven liquidity traps. Raising the inflation target or appointing an inflation-conservative central banker improves inflation outcomes away from the lower bound but exacerbates the shortfall at the lower bound. Using government spending as an additional policy tool worsens stabilization outcomes both at and away from the lower bound. However, appointing a policymaker who is sufficiently less concerned with government spending stabilization than society can eliminate expectations-driven liquidity traps altogether.

No. 2303
31 July 2019
Monetary policy shocks and the health of banks

Abstract

JEL Classification

E40 : Macroeconomics and Monetary Economics→Money and Interest Rates→General

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

Based on high frequency identification and other econometric tools, we find that monetary policy shocks had a significant impact on the health of euro area banks. Information effects, which made the private sector more pessimistic about future prospects of the economy and the profitability of the banking sector, were strongly present in the post-crisis period. We show that ECB communications at the press conference were crucial for the market response and that bank health benefitted from surprises, which steepened the yield curve. We find that the effects of monetary policy shocks on banks displayed some persistence. Other bank characteristics, in particular bank size, leverage and NPL ratios, amplified the impact of monetary policy shocks on banks. After the OMT announcement, we detect that the response of bank stocks to monetary policy shocks normalised. We discover that, in the post-crisis episode, Fed monetary policy shocks influenced euro area bank stock valuations.

No. 2302
31 July 2019
The macroeconomic effects of international uncertainty

Abstract

JEL Classification

C30 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→General

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

Abstract

This paper proposes a large-scale Bayesian vector autoregression with factor stochastic volatility to investigate the macroeconomic consequences of international uncertainty shocks in G7 countries. The curse of dimensionality is addressed by means of a global-local shrinkage prior that mimics certain features of the well-known Minnesota prior, yet provides additional flexibility in terms of achieving shrinkage. The factor structure enables us to identify an international uncertainty shock by assuming that it is the joint volatility process that determines the dynamics of the variance-covariance matrix of the common factors. To allow for first and second moment shocks we, moreover, assume that the uncertainty factor enters the VAR equation as an additional regressor. Our findings suggest that the estimated uncertainty measure is strongly connected to global equity price volatility, closely tracking other prominent measures commonly adopted to assess uncertainty. The dynamic responses of a set of macroeconomic and financial variables show that an international uncertainty shock exerts large effects on all economies and variables under consideration.

No. 2301
30 July 2019
International debt and Special Purpose Entities: evidence from Ireland

Abstract

JEL Classification

F36 : International Economics→International Finance→Financial Aspects of Economic Integration

G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

G15 : Financial Economics→General Financial Markets→International Financial Markets

Abstract

This paper examines international debt issuance through Irish-resident Special Purpose Entities (SPEs). Using a unique new dataset covering the population of Irish-resident SPEs reporting to the Central Bank of Ireland over the period 2005-2017, we identify cross-country debt financing links channelled through SPEs. The empirical analysis suggests that tax optimisation is an important motive, particularly for sponsors of Irish-resident securitisation vehicles, while investor protection and financial development are important additional considerations for sponsors of non-securitisation vehicles.

No. 2300
30 July 2019
Fast trading and the virtue of entropy: evidence from the foreign exchange market

Abstract

JEL Classification

F31 : International Economics→International Finance→Foreign Exchange

G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading

G15 : Financial Economics→General Financial Markets→International Financial Markets

Abstract

Focusing on the foreign exchange reaction to macroeconomic announcements, we show that fast trading is positively and significantly correlated with the entropy of the distribution of quoted prices in reaction to news: a larger share of fast trading increases the degree of diversity of quotes in the order book, for given liquidity, order book depth and size of order flows. Exploiting the WM Reuters’ reform of the fixing methodology in February 2015 as a natural experiment, we provide evidence that fast trading raises entropy, rather than reacting to it. While more entropy in quoted prices means noisier information and arguably complicates price discovery from an individual trader’s perspective, we show that, in the aggregate, more entropy actually brings traded prices closer to the random walk hypothesis, and improves indicators of market efficiency and quality of trade execution. We estimate that a 10 percent increase in entropy reduces the negative impact of macro news by over 60% for effective spreads, against over 40% for realized spreads and price impacts. Our findings suggest that the main mechanism by which fast trading may have desirable effects on market performance specifically hinges on enhanced heterogeneity in trading patterns, best captured by entropy.

No. 2299
29 July 2019
Insurers’ investment strategies: pro- or countercyclical?

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises

G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions

G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates

G22 : Financial Economics→Financial Institutions and Services→Insurance, Insurance Companies, Actuarial Studies

G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

Abstract

Traditionally, insurers are seen as stabilisers of financial markets that act countercyclically by buying assets whose price falls. Recent studies challenge this view by providing empirical evidence of procyclicality. This paper sheds new light on the underlying reasons for these opposing views. Our model predicts procyclicality when prices fall due to increasing risk premia, and countercyclicality in response to rises in the risk-free rate. Using granular data on insurers’ government bond holdings, we validate these predictions empirically. Our findings contribute to the current policy discussion on macroprudential measures beyond banking.

No. 2298
29 July 2019
Behind the scenes of the beauty contest: window dressing and the G-SIB framework

Abstract

JEL Classification

G20 : Financial Economics→Financial Institutions and Services→General

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

This paper illustrates that systemically important banks reduce a range of activities at year-end, leading to lower additional capital requirements in the form of G-SIB buffers. The effects are stronger for banks with higher incentives to reduce the indicators, and for banks with balance sheet structures that can more easily be adjusted. The observed reduction in activity may imply an overall underestimation of banks' systemic importance as well as a distortion in their relative ranking, with implications for banks' ability to absorb losses. Moreover, a reduction in the provision of certain services at year-end may adversely affect overall market functioning.

No. 2297
26 July 2019
Monetary policy, macroprudential policy, and financial stability

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

This paper reexamines from a theoretical perspective the role of monetary and macroprudential policies in addressing the build-up of risks in the financial system. We construct a stylized general equilibrium model in which the key friction comes from a moral hazard problem in firms financing that banks’ equity capital serves to ameliorate. Tight monetary policy is introduced by open market sales of government debt, and tight macroprudential policy by an increase in capital requirements. We show that both policies are useful, but macroprudential policy is more effective in fostering financial stability and leads to higher social welfare.

No. 2296
26 July 2019
Disentangling the role of the exchange rate in oil-related scenarios for the European stock market

Abstract

JEL Classification

E30 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→General

E37 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Forecasting and Simulation: Models and Applications

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

G10 : Financial Economics→General Financial Markets→General

Abstract

Until now, stock market responses to a distress scenario for oil prices have been analysed considering prices in domestic currency. This assumption implies merging the commodity risk with the exchange rate risk when oil and stocks are traded in different currencies. This article proposes incorporating explicitly the exchange rate, using the convolution concept, to assess how could change the stock market response depending on the source of risk that moves oil prices. I apply this framework to study the change in the 10th lowest percentile of the European stock market under an oil-related stress scenario, without overlooking the role of the exchange rate. The empirical exercise shows that the same stress oil-related scenario in euros could generate an opposite impact in the European stock market depending on the source of risk. The source of risk is not incorporated when performing a bivariate analysis, which suggests ambiguous estimates of the stock response. This framework can improve our understanding of how the exchange rate interacts in global markets. Also, it contributes to reduce the inaccuracy in the impact assessment of foreign shocks where the exchange rate plays a relevant role.

No. 2295
17 July 2019
Phillips curves in the euro area

Abstract

JEL Classification

C30 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→General

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

Abstract

We perform a robust estimation of the Phillips curve in the euro area using a battery of 630 theory-driven models. We extend the existing literature by adding model specifications, taking into account the uncertainty in the measurement of variables and testing for potential non-linearities and structural changes. Using Dynamic Model Averaging, we identify the most important determinants of inflation over the sample. We then forecast core inflation 12 quarters ahead and present its probability distribution. We compare the distribution of forecasts performed in recent years, and we assess, in a probabilistic manner, the convergence towards a sustainable path of inflation.

No. 2294
10 July 2019
An agent-based model for the assessment of LTV caps

Abstract

JEL Classification

D14 : Microeconomics→Household Behavior and Family Economics→Household Saving; Personal Finance

D31 : Microeconomics→Distribution→Personal Income, Wealth, and Their Distributions

E50 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→General

R21 : Urban, Rural, Regional, Real Estate, and Transportation Economics→Household Analysis→Housing Demand

Abstract

We assess the effects of regulatory caps in the loan-to-value (LTV) ratio using agent-based models (ABMs). Our approach builds upon a straightforward ABM where we model the interactions of sellers, buyers and banks within a computational framework that enables the application of LTV caps. The results are first presented using simulated data and then we calibrate the probability distributions based on actual European data from the HFCS survey. The results suggest that this approach can be viewed as a useful alternative to the existing analytical frameworks for assessing the impact of macroprudential measures, mainly due to the very few assumptions the method relies upon and the ability to easily incorporate additional and more complex features related to the behavioral response of borrowers to such measures.

No. 2293
8 July 2019
Tracing the impact of the ECB’s asset purchase programme on the yield curve

Abstract

JEL Classification

C5 : Mathematical and Quantitative Methods→Econometric Modeling

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates

Abstract

We trace the impact of the ECB’s asset purchase programme (APP) on the sovereign yield curve. Exploiting granular information on sectoral asset holdings and ECB asset purchases, we construct a novel measure of the “free-float of duration risk” borne by price-sensitive investors. We include this supply variable in an arbitrage-free term structure model in which central bank purchases reduce the free-float of duration risk and hence compress term premia of yields. We estimate the stock of current and expected future APP holdings to reduce the 10y term premium by 95 bps. This reduction is persistent, with a half-life of five years. The expected length of the reinvestment period after APP net purchases is found to have a significant impact on term premia.

No. 2292
28 June 2019
Impact of higher capital buffers on banks’ lending and risk-taking: evidence from the euro area experiments

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We study the impact of higher bank capital buffers, namely of the Other Systemically Important Institutions (O-SII) buffer, on banks' lending and risk-taking behaviour. The O-SII buffer is a macroprudential policy aiming to increase banks' resilience. However, higher capital requirements associated with the policy may likely constrain lending. While this may be a desired effect of the policy, it could, at least in the short-term, pose costs for economic activity. Moreover, by changing the relative attractiveness of different asset classes, a higher capital requirement could also lead to risk-shifting and therefore promote the build-up (or deleverage) of banks' risk-taking. Since the end of 2015, national authorities, under the EBA framework, started to identify banks as O-SII and impose additional capital buffers. The identification of the O-SII is mainly based on a cutoff rule, ie. banks whose score is above a certain threshold are automatically designated as systemically important. This feature allows studying the effects of higher capital requirements by comparing banks whose score was close to the threshold. Relying on confidential granular supervisory data, between 2014 and 2017, we find that banks identified as O-SII reduced, in the short-term, their credit supply to households and financial sectors and shifted their lending to less risky counterparts within the non-financial corporations. In the medium-term, the impact on credit supply is defused and banks shift their lending to less risky counterparts within the financial and household sectors. Our findings suggest that the discontinuous policy change had limited effects on the overall supply of credit although we find evidence of a reduction in the credit supply at the inception of the macroprudential policy. This result supports the hypothesis that the implementation of the O-SII's framework could have a positive disciplining effect by reducing banks' risk-taking while having only a reduced adverse impact

No. 2291
11 June 2019
An analysis of the Eurosystem/ECB projections

Abstract

JEL Classification

C53 : Mathematical and Quantitative Methods→Econometric Modeling→Forecasting and Prediction Methods, Simulation Methods

E37 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Forecasting and Simulation: Models and Applications

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

Abstract

The Eurosystem/ECB staff macroeconomic projection exercises constitute an important input to the ECB's monetary policy. This work marks a thorough analysis of the Eurosystem/ECB projection errors by looking at criteria of optimality and rationality using techniques widely employed in the applied literature of forecast evaluation. In general, the results are encouraging and suggest that Eurosystem/ECB staff projections abide to the main characteristics that constitute them reliable as a policy input. Projections of GDP - up to one year - and inflation are optimal - in the case of inflation they are also rational. A main finding is that GDP forecasts can be substantially improved, especially at long horizons.

No. 2290
11 June 2019
Competition among high-frequency traders, and market quality

Abstract

JEL Classification

G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates

G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading

G15 : Financial Economics→General Financial Markets→International Financial Markets

G18 : Financial Economics→General Financial Markets→Government Policy and Regulation

G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

D4 : Microeconomics→Market Structure and Pricing

D61 : Microeconomics→Welfare Economics→Allocative Efficiency, Cost?Benefit Analysis

Abstract

We study empirically how competition among high-frequency traders (HFTs) affects their trading behavior and market quality. Our analysis exploits a unique dataset, which allows us to compare environments with and without high-frequency competition, and contains an exogenous event - a tick size reform - which we use to disentangle the effects of the rising share of high-frequency trading in the market from the effects of high-frequency competition. We find that when HFTs compete, their speculative trading increases. As a result, market liquidity deteriorates and short-term volatility rises. Our findings hold for a variety of market quality and high-frequency trading behavior measures.

No. 2289
7 June 2019
Is there a zero lower bound? The effects of negative policy rates on banks and firms

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

D22 : Microeconomics→Production and Organizations→Firm Behavior: Empirical Analysis

D25 : Microeconomics→Production and Organizations

Abstract

Exploiting confidential data from the euro area, we show that sound banks can pass negative rates on to their corporate depositors without experiencing a contraction in funding. These pass-through effects become stronger as policy rates move deeper into negative territory. Banks offering negative rates provide more credit than other banks suggesting that the transmission mechanism of monetary policy is not hampered. The negative interest rate policy (NIRP) provides further stimulus to the economy through firms’ asset rebalancing. Firms with high current assets linked to banks offering negative rates appear to increase their investment in tangible and intangible assets and to decrease their cash holdings to avoid the costs associated with negative rates. Overall, our results challenge the commonly held view that conventional monetary policy becomes ineffective when policy rates reach the zero lower bound.

No. 2288
7 June 2019
The procyclicality of banking: evidence from the euro area

Abstract

JEL Classification

G20 : Financial Economics→Financial Institutions and Services→General

Abstract

Loan loss provisions in the euro area are negatively related to GDP growth, i.e., they are procyclical. Loan loss provisions tend to be more procyclical at larger and better capitalized banks. The procyclicality of loan loss provisions can explain about two-thirds of the variation of bank capitalization over the business cycle. We estimate that provisioning procyclicality in the euro area is about twice as large as in other advanced economies. This difference reflects a larger procyclicality of provisioning in euro area countries already prior to euro adoption, and the divergent growth experiences of euro area countries following the global financial crisis.

No. 2287
27 May 2019
The architecture of supervision

Abstract

JEL Classification

E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

G38 : Financial Economics→Corporate Finance and Governance→Government Policy and Regulation

Abstract

The architecture of supervision – how we define the allocation of supervisory powers to different policy institutions – can have implications for policy conduct and for the economic and financial environment in which these policies are implemented. Theoretically, an integrated structure for monetary policy and supervision brings important benefits arising from better information flow and policy coordination. Aggregate supervisory information may significantly improve the conduct of monetary policy and the effectiveness of the lender of last resort function. As long as the process towards an integrated structure does not shrink the set of available tools, monetary policy and supervision are no less effective in pursuing their objectives than a separated structure. Additionally, an integrated structure does not seem to be correlated with more price and/or financial instability, as suggested by analysing a large global set of countries with different supervisory set-ups. A centralised structure for supervision entails significant benefits in terms of fewer opportunities for supervisory arbitrage by banks and less informational asymmetry. A large central supervisor can take advantage of economies of scale and scope in supervision and gain a broader perspective on the stability of the entire banking sector, which should result in improved financial stability. Potential drawbacks of a centralised supervisory structure are the possible lack of specialisation relative to local supervisors and the increased distance between the supervisor and the supervised institutions. We discuss the implications of our findings in the euro area context and in relation to the design of the Single Supervisory Mechanism (SSM).

No. 2286
24 May 2019
Bank capital in the short and in the long run

Abstract

JEL Classification

E3 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

G01 : Financial Economics→General→Financial Crises

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

How far should capital requirements be raised in order to ensure a strong and resilient banking system without imposing undue costs on the real economy? Capital requirement increases make banks safer and are beneficial in the long run but also entail transition costs because their imposition reduces credit supply and aggregate demand on impact. In the baseline scenario of a quantitative macro-banking model, 25% of the long-run welfare gains are lost due to transitional costs. The strength of monetary policy accommodation and the degree of bank riskiness are key determinants of the trade-off between the short-run costs and long-run benefits from changes in capital requirements.

No. 2285
23 May 2019
Cross-border effects of prudential regulation: evidence from the euro area

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

F34 : International Economics→International Finance→International Lending and Debt Problems

F36 : International Economics→International Finance→Financial Aspects of Economic Integration

Abstract

We analyse the cross-border propagation of prudential regulation in the euro area. Using the Prudential Instruments Database (Cerutti et al., 2017b) and a unique confidential database on balance sheets items of euro-area financial institutions we estimate panel models for 248 banks from 16 euro-area countries. We find that domestic banks reduce lending after the tightening of capital requirements in other countries, while they increase lending when loan-to-value (LTV) limits or reserve requirements are tightened abroad. We also find that foreign affiliates increase lending following the tightening of sector-specific capital buffers in the countries where their parent banks reside and that bank size and liquidity play a role in determining the magnitude of cross-border spillovers.

No. 2284
22 May 2019
Rules and discretion(s) in prudential regulation and supervision: evidence from EU banks in the run-up to the crisis

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

Prior to the financial crisis, prudential regulation in the EU was implemented non-uniformly across countries, as options and discretions allowed national authorities to apply a more favorable regulatory treatment. We exploit the national implementation of the CRD and derive a country measure of regulatory flexibility (for all banks in a country) and of supervisory discretion (on a case-by-case basis). Overall, we find that banks established in countries with a less stringent prudential framework were more likely to require public support during the crisis. We instrument some characteristics of bank balance sheets with these prudential indicators to investigate how they affect bank resilience. The share of non-interest income explained by the prudential environment is always associated with an increase in the likelihood of financial distress during the crisis. Prudential frameworks also explain banks’ liquidity buffers even in absence of a specific liquidity regulation, which points to possible spillovers across regulatory instruments.

No. 2283
20 May 2019
Negative interest rates, excess liquidity and retail deposits: banks’ reaction to unconventional monetary policy in the euro area

Abstract

JEL Classification

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

Negative monetary policy rates are associated with a particular friction because the remuneration of retail deposits tends to be floored at zero. We investigate whether this friction affects banks’ reactions when the policy rate is lowered to negative levels, compared to a standard rate cut in the euro area. We exploit the cross-sectional variation in banks’ funding structures jointly with that in their excess liquidity holdings. We find evidence that banks highly exposed to the policy tend to grant more loans. This confirms studies that point to higher risk taking by banks as a reaction to negative rates. It, however, contrasts some earlier research associating negative rates with a contraction in loans. We illustrate that the difference is likely driven by the broader coverage of our loan data, longer time span of our sample and, importantly, the explicit consideration of the role of excess liquidity in our analysis.

No. 2282
20 May 2019
EME financial conditions: which global shocks matter?

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

G15 : Financial Economics→General Financial Markets→International Financial Markets

Abstract

This paper provides a quantitative assessment of the relative importance of global structural shocks for changes in financial conditions across a sample of emerging market economies. We disentangle four key drivers of global financial markets (oil supply shocks, global economic news shocks, US-specific economic news shocks and US monetary shocks) and show that these global factors account for about half of the variation in risky asset prices across EMEs. The influence of global factors for EME interest rates and currencies is much smaller, suggesting that factors beyond the identified global shocks (e.g. domestic or regional shocks) might be more important. In contrast to the recent literature on the global financial cycle which has emphasised the prominent role of US monetary policy, we find that although US monetary shocks have some influence in shaping EME financial markets, the broader global environment plays a significantly stronger role.

No. 2281
17 May 2019
Measuring euro area monetary policy

Abstract

JEL Classification

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates

G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading

Abstract

We study the information flow from the ECB on policy dates since its inception, using tick data. We show that three factors capture about all of the variation in the yield curve but that these are different factors with different variance shares in the window that contains the policy decision announcement and the window that contains the press conference. We also show that the QE-related policy factor has been dominant in the recent period and that Forward Guidance and QE effects have been very persistent on the longer-end of the yield curve. We further show that broad and banking stock indices’ responses to monetary policy surprises depended on the perceived nature of the surprises. We find no evidence of asymmetric responses of financial markets to positive and negative surprises, in contrast to the literature on asymmetric real effects of monetary policy. Lastly, we show how to implement our methodology for any policy-related news release, such as policymaker speeches. To carry out the analysis, we construct the Euro Area Monetary Policy Event-Study Database (EA-MPD). This database, which contains intraday asset price changes around the policy decision announcement as well as around the press conference, is a contribution on its own right and we expect it to be the standard in monetary policy research for the euro area.

No. 2280
15 May 2019
The global capital flows cycle: structural drivers and transmission channels

Abstract

JEL Classification

E42 : Macroeconomics and Monetary Economics→Money and Interest Rates→Monetary Systems, Standards, Regimes, Government and the Monetary System, Payment Systems

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

F31 : International Economics→International Finance→Foreign Exchange

F36 : International Economics→International Finance→Financial Aspects of Economic Integration

F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics

Abstract

In this paper, we study the effects of structural shocks that influence global risk – the main factor behind a “global capital flows cycle” – and how risk, in turn, is transmitted to capital flows. Our results show that not all the risk shocks driving the global financial cycle have the same effects on capital flows. Changes in global risk caused by pure financial shocks have the largest impact on the global configuration of capital flows, followed by US monetary policy shocks. As regards the transmission of risk to capital flows, we uncover a traditional “trilemma”, as countries more financially open and adopting a strict peg are more sensitive to global risk. This “trilemma” is mainly driven by one category of cross-border flows, “other investment”, confirming the importance of cross-border banking loans in the narrative of the global financial cycle.

No. 2279
10 May 2019
Uncertainty shocks, monetary policy and long-term interest rates

Abstract

JEL Classification

C11 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Bayesian Analysis: General

C34 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Truncated and Censored Models, Switching Regression Models

E40 : Macroeconomics and Monetary Economics→Money and Interest Rates→General

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

We study the relationship between monetary policy and long-term rates in a structural, general equilibrium model estimated on both macro and yields data from the United States. Regime shifts in the conditional variance of productivity shocks, or "uncertainty shocks", are an important model ingredient. First, they account for countercyclical movements in risk premia. Second, they induce changes in the demand for precautionary saving, which affects expected future real rates. Through changes in both risk-premia and expected future real rates, uncertainty shocks account for about 1/2 of the variance of long-term nominal yields over long horizons. The remaining driver of long-term yields are changes in inflation expectations induced by conventional, autoregressive shocks. Long-term inflation expectations implied by our model are in line with those based on survey data over the 1980s and 1990s, but less strongly anchored in the 2000s.

No. 2278
6 May 2019
Targeting financial stability: macroprudential or monetary policy?

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

G01 : Financial Economics→General→Financial Crises

G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

This paper explores monetary-macroprudential policy interactions in a simple, calibrated New Keynesian model incorporating the possibility of a credit boom precipitating a financial crisis and a loss function reflecting financial stability considerations. Deploying the countercyclical capital buffer (CCyB) improves outcomes significantly relative to when interest rates are the only instrument. The instruments are typically substitutes, with monetary policy loosening when the CCyB tightens. We also examine when the instruments are complements and assess how different shocks, the effective lower bound for monetary policy, market-based finance and a risk-taking channel of monetary policy affect our results.

No. 2277
6 May 2019
Pockets of risk in European housing markets: then and now

Abstract

JEL Classification

E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit

G01 : Financial Economics→General→Financial Crises

G17 : Financial Economics→General Financial Markets→Financial Forecasting and Simulation

G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

R39 : Urban, Rural, Regional, Real Estate, and Transportation Economics→Real Estate Markets, Spatial Production Analysis, and Firm Location→Other

Abstract

Using household survey data, we document evidence of a loosening of credit standards in Euro area countries that experienced a property price boom-and-bust cycle. Borrowers in these countries exhibited significantly higher loan-to-value (LTV) and loan-to-income (LTI) ratios in the run up to the financial crisis, and an increasing tendency towards longer-term loans compared to borrowers in other countries. In recent years, despite the long period of historically low interest rates and substantial house price increases in some countries, we do not find similar credit easing as before the crisis. Instead, we find evidence of a considerable change in borrower characteristics since 2010: new borrowers are older and have higher incomes than before the crisis.

No. 2276
3 May 2019
Institutional presence in secondary bank bond markets: how does it affect liquidity and volatility?

Abstract

JEL Classification

G10 : Financial Economics→General Financial Markets→General

G15 : Financial Economics→General Financial Markets→International Financial Markets

G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

Abstract

Using newly available information on euro area sectoral holdings of securities, this paper investigates to what extent the presence of institutional investors affects volatility and liquidity in secondary bank bond markets. We find that non-bank financial intermediaries, in particular money market funds (MMFs), have a positive impact on secondary bank bond markets’ liquidity conditions, at the cost of significantly increasing volatility of daily returns. The effect translates to more than a 19% improvement in liquidity conditions and up to 57% increase in daily-return volatility, assuming MMFs hold about 10% of the notional amount in the secondary market of a representative euro area bank bond. The effect is relative to the impact the non-financial private sector has on markets. Investment funds, insurance corporations and pension funds are found to similarly affect market conditions, though to a lesser magnitude. We find a trade-off between volatility and liquidity, where the stronger presence of institutional investors at the same time improves liquidity and increases volatility. The results suggest that possible structural shifts in investor composition matter for market conditions and should be monitored by financial stability authorities.

No. 2275
30 April 2019
Did the euro change the nature of FDI flows among member states?

Abstract

JEL Classification

F21 : International Economics→International Factor Movements and International Business→International Investment, Long-Term Capital Movements

F23 : International Economics→International Factor Movements and International Business→Multinational Firms, International Business

F45 : International Economics→Macroeconomic Aspects of International Trade and Finance

O43 : Economic Development, Technological Change, and Growth→Economic Growth and Aggregate Productivity→Institutions and Growth

Abstract

In this paper we investigate the impact of the euro integration process on the drivers of FDI inflows. We show theoretically and empirically that the single currency alters the drivers of FDI inflows across its Member States. Estimating bilateral gravity models of FDI inflows into euro area countries, we show that the euro facilitates intra-euro area vertical FDI flows but reduces incentives for horizontal or market seeking FDI. Instead, horizontal FDI flows stemming from investor countries located outside the monetary union increase. Such flows are however not more likely be directed towards euro area countries with larger domestic markets but rather to countries that are close to large euro area markets and that have higher quality institutions. Overall, these results suggest that while the euro has been beneficial to FDI inflows into the monetary union, the impact differs significantly across countries. The global financial crisis does not change our main findings. Our results are robust to various economic specifications.

No. 2274
29 April 2019
Credit rating dynamics: evidence from a natural experiment

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

G24 : Financial Economics→Financial Institutions and Services→Investment Banking, Venture Capital, Brokerage, Ratings and Ratings Agencies

G30 : Financial Economics→Corporate Finance and Governance→General

Abstract

This paper investigates the behaviour of credit rating agencies (CRAs) using a natural experiment in monetary policy. Specifically, we exploit the corporate QE of the Eurosystem and its rating-based specific design which generates exogenous variation in the probability for a bond of becoming eligible for outright purchases. We show that after the launch of the policy, rating upgrades were mostly noticeable for bonds initially located below, but close to, the eligibility frontier. In line with the theory, rating activity is concentrated precisely on the territory where the incentives of market participants are expected to be more sensitive to the policy design. Complementing the evidence on the effectiveness of non-standard measures, our findings contribute to better assessing the consequences of the explicit (but not exclusive) reliance on CRAs ratings by central banks when designing monetary policy.

No. 2273
26 April 2019
Mapping bank securities across euro area sectors: comparing funding and exposure networks

Abstract

JEL Classification

D85 : Microeconomics→Information, Knowledge, and Uncertainty→Network Formation and Analysis: Theory

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

L14 : Industrial Organization→Market Structure, Firm Strategy, and Market Performance→Transactional Relationships, Contracts and Reputation, Networks

Abstract

We present new evidence on the structure of euro area securities markets using a multilayer network approach. Layers are broken down by key instruments and maturities as well as the secured nature of the transaction. This paper utilizes a unique dataset of banking sector crossholdings of securities to map these exposures among banks and economic and financial sectors. We can compare and contrast funding and exposure networks among banks themselves and of banks, non-banks and the wider economy. The analytical approach presented here is highly relevant for the design of appropriate prudential measures, since it supports the identification of counterparty risk, concentration risk and funding risk within the interbank network and the wider macro-financial network.

No. 2272
26 April 2019
Monetary policy implications of state-dependent prices and wages

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

D81 : Microeconomics→Information, Knowledge, and Uncertainty→Criteria for Decision-Making under Risk and Uncertainty

C73 : Mathematical and Quantitative Methods→Game Theory and Bargaining Theory→Stochastic and Dynamic Games, Evolutionary Games, Repeated Games

Abstract

We study the effects of monetary shocks in a model of state-dependent price and wage adjustment based on “control costs”. Suppliers of retail goods and of labor are both monopolistic competitors that face idiosyncratic productivity shocks and nominal rigidities. Stickiness arises because precise decisions are costly, so agents choose to tolerate small errors in the timing of adjustments. Our simulations are calibrated to microdata on the size and frequency of price and wage changes. Money shocks have less persistent real effects in our state-dependent model than they would a time-dependent framework, but nonetheless we obtain sufficient monetary nonneutrality for consistency with macroeconomic evidence. Nonneutrality is primarily driven by wage rigidity, rather than price rigidity. State-dependent nominal rigidity implies a flatter Phillips curve as trend inflation declines, because nominal adjustments become less frequent, making short-run inflation less reactive to shocks.

No. 2271
23 April 2019
Credit supply and human capital: evidence from bank pension liabilities
ECB Lamfalussy Fellowship Programme

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

J21 : Labor and Demographic Economics→Demand and Supply of Labor→Labor Force and Employment, Size, and Structure

J24 : Labor and Demographic Economics→Demand and Supply of Labor→Human Capital, Skills, Occupational Choice, Labor Productivity

Abstract

We identify the effects of exogenous credit constraints on firm ability to attract and retain skilled workers. To do so, we exploit a shock to the value of the pension obligations of Portuguese banks resulting from a change in accounting norms. Using bank-firm credit exposures that we match with a census of all Portuguese employees, we show that firms in a relationship with affected banks borrow less and reduce employment mostly of high-skilled workers. High-skilled workers are more likely to exit and less likely to join affected firms. Overall, credit market frictions might have long lasting effects on firm productivity and growth through firm accumulation of human capital.

No. 2270
18 April 2019
Risky assets in Europe and the US: risk vulnerability, risk aversion and economic environment

Abstract

JEL Classification

D12 : Microeconomics→Household Behavior and Family Economics→Consumer Economics: Empirical Analysis

D14 : Microeconomics→Household Behavior and Family Economics→Household Saving; Personal Finance

D31 : Microeconomics→Distribution→Personal Income, Wealth, and Their Distributions

G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions

Abstract

We use cross-country microdata to analyse the risk taking of households in Europe and the US. Concerning the extensive as well as the intensive margin of risky assets, European households differ substantially from US households; but also inside Europe we document substantial differences. Furthermore, average risk aversion is strongly correlated with the share of households holding risky assets across countries. We decompose the observed differences into two parts. A part explainable by household characteristics as well as differences in risk aversion and a remainder. We employ the unexplained part resulting from our microeconometric decomposition analysis together with country-level variables on the economic environment to relate observed differences in risky asset holdings to institutional ones. We find that institutional differences such as shareholder protection are strongly correlated with the unexplainable differences with regard to holdings of risky assets.

No. 2269
18 April 2019
Shocks and labour cost adjustment: evidence from a survey of European firms

Abstract

JEL Classification

D21 : Microeconomics→Production and Organizations→Firm Behavior: Theory

D22 : Microeconomics→Production and Organizations→Firm Behavior: Empirical Analysis

D24 : Microeconomics→Production and Organizations→Production, Cost, Capital, Capital, Total Factor, and Multifactor Productivity, Capacity

Abstract

We use firm-level survey data from 25 EU countries to analyse how firms adjust their labour costs (employment, wages and hours) in response to shocks. We develop a theoretical model to understand how firms choose between different ways to adjust their labour costs. The basic intuition is that firms choose the cheapest way to adjust labour costs. Our empirical findings are in line with the theoretical model and show that the pattern of adjustment is not much affected by the type of the shock (demand shock, access-to-finance shock, ‘availability of supplies’ shock), but differs according to the direction of the shock (positive or negative), its size and persistence. In 2010-13, firms responding to negative shocks were most likely to reduce employment, then hourly wages and then hours worked, regardless of the source of the shock. Results for the 2008-09 period indicate that the ranking might change during deep recession as the likelihood of wage cuts increases. In response to positive shocks in 2010-13, firms were more likely to increase wages, followed by increases in employment and then hours worked suggesting an asymmetric reaction to positive and negative shocks. Finally, we show that strict employment protection legislation and high centralisation or coordination of wage bargaining make it less likely that firms reduce wages when facing negative shocks.

No. 2268
17 April 2019
Dynamic fiscal limits and monetary-fiscal policy interactions

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination

E63 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Comparative or Joint Analysis of Fiscal and Monetary Policy, Stabilization, Treasury Policy

Abstract

This paper analyzes the impact of monetary policy on public debt sustainability through the lens of a general equilibrium model with fiscal limits. We find that the mere possibility of a binding ZLB may have detrimental effects on debt sustainability, as a kink in the Laffer curve induces a dead-weight loss in the present discounted value of future primary surpluses. Moreover, debt sustainability improves with monetary policy activeness, that is, with the elasticity of the interest rate to changes in inflation and the output gap. On this basis, we assess the trade-off between economic stabilization and debt sustainability depending on the monetary policy environment. In normal times, large public spending shocks may engender perverse debt dynamics and cause economic contractions. At the ZLB, a muted trade-off between stabilization and sustainability instead expands the fiscal margin, especially if coupled with a commitment to a more active monetary policy during normal times.

No. 2267
17 April 2019
Monetary policy spillovers, capital controls and exchange rate flexibility, and the financial channel of exchange rates

Abstract

JEL Classification

F42 : International Economics→Macroeconomic Aspects of International Trade and Finance→International Policy Coordination and Transmission

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

C50 : Mathematical and Quantitative Methods→Econometric Modeling→General

Abstract

We assess the empirical validity of the trilemma (or impossible trinity) in the 2000s for a large sample of advanced and emerging economies. To do so, we estimate Taylor-rule type monetary policy reaction functions, relating the local policy rate to real-time forecasts of domestic fundamentals, global variables, as well as the base-country policy rate. In the regressions, we explore variations in the sensitivity of local to base-country policy rates across different degrees of exchange rate flexibility and capital controls. We find that the data are in general consistent with the predictions from the trilemma: Both exchange rate flexibility and capital controls reduce the sensitivity of local to base-country policy rates. However, we also find evidence that is consistent with the notion that the financial channel of exchange rates highlighted in recent work reduces the extent to which local policymakers decide to exploit the monetary autonomy in principle granted by flexible exchange rates in specific circumstances: The sensitivity of local to base-country policy rates for an economy with a flexible exchange rate is stronger when it exhibits negative foreign-currency exposures which stem from portfolio debt and bank liabilities on its external balance sheet and when base-country monetary policy is tightened. The intuition underlying this finding is that it may be optimal for local monetary policy to mimic the tightening of base-country monetary policy and thereby mute exchange rate variation because a depreciation of the local currency would raise the cost of servicing and rolling over foreign-currency debt and bank loans, possibly up to a point at which financial stability is put at risk.

No. 2266
16 April 2019
Collateral booms and information depletion

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

G01 : Financial Economics→General→Financial Crises

D80 : Microeconomics→Information, Knowledge, and Uncertainty→General

Abstract

We develop a new theory of information production during credit booms. In our model, entrepreneurs need credit to undertake investment projects, some of which enable them to divert resources towards private consumption. Lenders can protect themselves from such diversion in two ways: collateralization and costly screening, which generates durable information about projects. In equilibrium, the collateralization-screening mix depends on the value of aggregate collateral. High collateral values raise investment and economic activity, but they also raise collateralization at the expense of screening. This has important dynamic implications. During credit booms driven by high collateral values (e.g. real estate booms), the economy accumulates physical capital but depletes information about investment projects. As a result, collateral-driven booms end in deep crises and slow recoveries: when booms end, investment is constrained both by the lack of collateral and by the lack of information on existing investment projects, which takes time to rebuild. We provide new empirical evidence using US firm-level data in support of the model's main mechanism.

No. 2265
16 April 2019
The gender promotion gap: evidence from central banking

Abstract

JEL Classification

J16 : Labor and Demographic Economics→Demographic Economics→Economics of Gender, Non-labor Discrimination

J31 : Labor and Demographic Economics→Wages, Compensation, and Labor Costs→Wage Level and Structure, Wage Differentials

J41 : Labor and Demographic Economics→Particular Labor Markets→Labor Contracts

J63 : Labor and Demographic Economics→Mobility, Unemployment, Vacancies, and Immigrant Workers→Turnover, Vacancies, Layoffs

Abstract

We examine gender differences in career progression and promotions in central banking, a stereotypical male-dominated occupation, using confidential anonymized personnel data from the European Central Bank (ECB) during the period 2003-2017. A wage gap emerges between men and women within a few years of hiring, despite broadly similar entry conditions in terms of salary levels and other observables. We also find that women are less likely to be promoted to a higher salary band up until 2010 when the ECB issued a public statement supporting diversity and took several measures to support gender balance. Following this change, the promotion gap disappears. The gender promotion gap prior to this policy change is partly driven by the presence of children. Using 2012-2017 data on promotion applications and decisions, we explore the promotion process in depth, and confirm that during this most recent period women are as likely to be promoted as men. This results from a lower probability of women to apply for promotion, combined with a higher probability of women to be selected conditional on having applied. Following promotion, women perform better in terms of salary progression, suggesting that the higher probability to be selected is based on merit, not positive discrimination.

No. 2264
15 April 2019
The CSPP at work - yield heterogeneity and the portfolio rebalancing channel

Abstract

JEL Classification

G15 : Financial Economics→General Financial Markets→International Financial Markets

G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill

G38 : Financial Economics→Corporate Finance and Governance→Government Policy and Regulation

Abstract

We assess the impact of the corporate sector purchase programme (CSPP), the corporate arm of the ECB's quantitative easing, over its first year of activity (June 2016 - June 2017). Focusing on the primary bond market, we find evidence of a significant impact of the CSPP on yield spreads, both directly on purchased and targeted bonds and indirectly on all other bonds.The magnitude and the timing of the changes in yield spreads, coupled with the evolution of bond placements, are fully consistent with the proper unfolding the portfolio rebalancing channel.

No. 2263
15 April 2019
Can more public information raise uncertainty? The international evidence on forward guidance

Abstract

JEL Classification

D83 : Microeconomics→Information, Knowledge, and Uncertainty→Search, Learning, Information and Knowledge, Communication, Belief

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

Abstract

Central banks have used different types of forward guidance, where the forward guidance horizon is related to a state contingency, a calendar date or left open-ended. This paper reports cross-country evidence on the impact of these different types of forward guidance on the sensitivity of bond yields to macroeconomic news, and on forecaster disagreement about the future path of interest rates. We show that forward guidance mutes the response to macroeconomic news in general, but that calendar-based forward guidance with a short horizon counterintuitively raises it. Using a model where agents learn from market signals, we show that the release of more precise public information about future rates lowers the informativeness of market signals and, as a consequence, may increase uncertainty and amplify the reaction of expectations to macroeconomic news. However, when the increase in precision of public information is sufficiently large, uncertainty is unambiguously reduced.

No. 2262
12 April 2019
Once bitten: new evidence on the link between IMF conditionality and IMF stigma

Abstract

JEL Classification

F33 : International Economics→International Finance→International Monetary Arrangements and Institutions

F53 : International Economics→International Relations, National Security, and International Political Economy→International Agreements and Observance, International Organizations

F55 : International Economics→International Relations, National Security, and International Political Economy→International Institutional Arrangements

H87 : Public Economics→Miscellaneous Issues→International Fiscal Issues, International Public Goods

Abstract

While the consequences and effectiveness of IMF conditionality have long been the focus of research, the possible negative impact of IMF conditionality on countries’ willingness to ask for an IMF programme – often termed ‘IMF stigma’ – has recently received attention particularly from policy circles. In this paper we investigate how countries' past experience with the IMF and their peers’ experience with the IMF affect their likelihood of entering a subsequent IMF arrangement. Our results indicate that, even when controlling for the success of past programmes, a country is less likely to approach the IMF for help if in the past it experienced an above-average number of disbursement-relevant conditions. We find hardly any impact of peers’ experience, except for Asian countries.

No. 2261
12 April 2019
The benefits and costs of adjusting bank capitalisation: evidence from euro area countries

Abstract

JEL Classification

E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

The paper proposes a framework for assessing the impact of system-wide and bank-level capital buffers. The assessment rests on a factor-augmented vector autoregression (FAVAR) model that relates individual bank adjustments to macroeconomic dynamics. We estimate FAVAR models individually for eleven euro area economies and identify structural shocks, which allow us to diagnose key vulnerabilities of national banking systems and estimate short-run economic costs of increasing banks’ capitalisation. On this basis, we run a fully-fledged cost-benefit assessment of an increase in capital buffers. The benefits are related to an increase in bank resilience to adverse shocks. Higher capitalisation allows banks to withstand negative shocks and moderates the reduction of credit to the real economy that ensues in adverse circumstances. The costs relate to transitory credit and output losses that are assessed both on an aggregate and bank level. An increase in capital ratios is shown to have a sharply different impact on credit and economic activity depending on the way banks adjust, i.e. via changes in assets or equity.

No. 2260
29 March 2019
Macroprudential policy in a monetary union with cross-border banking

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

F36 : International Economics→International Finance→Financial Aspects of Economic Integration

F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics

Abstract

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.

No. 2259
28 March 2019
On the credit and exchange rate channels of central bank asset purchases in a monetary union

Abstract

JEL Classification

E4 : Macroeconomics and Monetary Economics→Money and Interest Rates

E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit

F4 : International Economics→Macroeconomic Aspects of International Trade and Finance

Abstract

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 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.

No. 2258
28 March 2019
Demographics and the natural real interest rate: historical and projected paths for the euro area

Abstract

JEL Classification

E17 : Macroeconomics and Monetary Economics→General Aggregative Models→Forecasting and Simulation: Models and Applications

E21 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Consumption, Saving, Wealth

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

J11 : Labor and Demographic Economics→Demographic Economics→Demographic Trends, Macroeconomic Effects, and Forecasts

Abstract

This paper employs an aggregate representation of an overlapping generation (OLG) model quantifying a decrease of the natural real interest rate in the range of -1.7 and -0.4 percentage points in the euro area between 1990 and 2030 due to demographics alone. Two channels contribute to this downward impact: the increasing scarcity of effective labor input and the increasing willingness to save by individuals due to longer life expectancy. The decrease of the aggregate saving rate as individuals retire has an upward impact which is never strong enough. Mitigating factors are: higher substitutability between labor and capital, higher intertemporal elasticity of substitution in consumption, reforms aiming at increasing the relative productivity of older cohorts, the participation rate and the retirement age. The simulated path of the natural real interest rate is consistent with recent econometric estimates: an upward trend in the 70s and 80s and a prolonged decline afterward.

No. 2257
27 March 2019
Taylor-rule consistent estimates of the natural rate of interest

Abstract

JEL Classification

C11 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Bayesian Analysis: General

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

We estimate the natural rate of interest for the US and the euro area in a semi-structural model comprising a Taylor rule. Our estimates feature key elements of Laubach and Williams (2003), but are more consistent with using conventional policy rules: we model inflation to be stationary, with the output gap pinning down deviations of inflation from its objective (rather than relative to a random walk). We relax some constraints on the correlation of latent factor shocks to make the original unobserved-components framework more amenable to structural interpretation and to reduce filtering uncertainty. We show that resulting natural rate metrics are more consistent with estimates from structural models.

No. 2256
27 March 2019
Does liquidity regulation impede the liquidity profile of collateral?

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

E42 : Macroeconomics and Monetary Economics→Money and Interest Rates→Monetary Systems, Standards, Regimes, Government and the Monetary System, Payment Systems

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

Abstract

We analyze the pledging behavior of Euro area banks during the introduction of the liquidity coverage ratio (LCR). The LCR considers only a subset of central bank eligible assets and thereby offers banks an arbitrage opportunity to improve their regulatory ratio by altering their collateral pledging with the European Central Bank. We use the existence of national liquidity requirements to proxy for banks’ incentives to exploit this differential treatment of central bank eligible assets. Using security-level information on collateral pledged with the central bank, we find that banks without a preceding national liquidity requirement pledge more and less liquid collateral than banks with a preceding national liquidity requirement after the LCR introduction. We attribute the difference across banks to a preparation effect of the liquidity regulation on the national level.

No. 2255
26 March 2019
Fiscal multipliers and foreign holdings of public debt

Abstract

JEL Classification

E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy

F32 : International Economics→International Finance→Current Account Adjustment, Short-Term Capital Movements

F34 : International Economics→International Finance→International Lending and Debt Problems

F36 : International Economics→International Finance→Financial Aspects of Economic Integration

F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics

F62 : International Economics→Economic Impacts of Globalization→Macroeconomic Impacts

F65 : International Economics→Economic Impacts of Globalization→Finance

G15 : Financial Economics→General Financial Markets→International Financial Markets

H63 : Public Economics→National Budget, Deficit, and Debt→Debt, Debt Management, Sovereign Debt

Abstract

This paper explores a natural connection between fiscal multipliers and foreign holdings of public debt. Although fiscal expansions can raise domestic economic activity through various channels, they can also have crowding-out effects if the resources used to acquire public debt reduce domestic consumption and investment. These crowding-out effects are likely to be weaker when governments have access to foreign markets to place their debt, increasing the size of multipliers. We test this hypothesis on (i) post-war US data and (ii) data for a panel of 17 advanced economies from the 1980's to the present. To do so, we assemble a novel database of public debt holdings by domestic and foreign creditors for a large set of advanced economies. We combine this data with standard measures of fiscal policy shocks and show that, indeed, the size of fiscal multipliers is increasing in the share of public debt held by foreigners. In particular, the fiscal multiplier is smaller than one when the foreign share is low, such as in the U.S. in the 1950's and 1960's and Japan today, and larger than one when the foreign share is high, such as in the U.S. and Ireland today.

No. 2254
26 March 2019
Stress testing household balance sheets in Luxembourg

Abstract

JEL Classification

D10 : Microeconomics→Household Behavior and Family Economics→General

D14 : Microeconomics→Household Behavior and Family Economics→Household Saving; Personal Finance

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

G01 : Financial Economics→General→Financial Crises

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

This paper uses representative individual household data from Luxembourg to evaluate how severe economic conditions could affect bank exposure to the household sector. Information on household income, expenses and liquid assets are used to calculate household-specific probabilities of default (PD), aggregate bank exposure at default (EAD) and aggregate bank loss given default (LGD). The exercise is repeated with scenarios combining severe but plausible shocks to real estate prices, bonds and stocks, household income and interest rates. Compared to the no-shock baseline, the LGD rises by a multiple of eight, reaching 4.2% of total bank exposure to the household sector. The high-stress scenario also generates a relatively high percentage of defaults among socio-economically disadvantaged households. Our main conclusion is that bank losses appear to be quite sensitive to financial stress, despite three mitigating factors in Luxembourg: indebted households tend to hold liquid assets that can help smooth shocks, household leverage tends to decline rapidly once mortgages have been serviced several years, and loan-to-value ratios at origination appear not to be excessive.

No. 2253
25 March 2019
Concentration, market power and dynamism in the euro area
Discussion papers

Abstract

JEL Classification

D2 : Microeconomics→Production and Organizations

D4 : Microeconomics→Market Structure and Pricing

N1 : Economic History→Macroeconomics and Monetary Economics, Industrial Structure, Growth, Fluctuations

O3 : Economic Development, Technological Change, and Growth→Technological Change, Research and Development, Intellectual Property Rights

Abstract

We examine the degree of market power in the big four countries of the euro area using macro and firm-micro data. We focus on three main indicators of market power in and across countries: namely, the concentration ratios, the markup and the degree of economic dynamism. For the macro database we use the sectoral data of KLEMs and for the micro data we use a combination of Orbis and iBACH (dating from 2006 onwards). We find that, in contrast to the situation in the US, market power metrics have been relatively stable over recent years and – in terms of the markup specifically – marginally trending down since the late 1990s, driven largely by Manufacturing. In terms of the debate as to the merits of market concentration, we find (relying on results for Manufacturing) that firms in sectors which exhibit high concentration, but are categorized as ‘high tech’ users, generally have higher TFP growth rates. By contrast, markups tend to display a bi-modal distribution when looked at through the lens of high concentration and high tech usage. These results would tend to confirm that the rise in market power documented for other economies is not obviously a euro area phenomenon and that welfare and policy analysis of market concentration is inevitably complex.

No. 2252
25 March 2019
Distance(s) and the volatility of international trade(s)

Abstract

JEL Classification

F10 : International Economics→Trade→General

F30 : International Economics→International Finance→General

Abstract

Does distance matter for the volatility of international real and financial transactions? We show that it does, in addition to its well-established relevance for the level of trade. A simple model of trade with endogenous markups shows that demand shocks have a larger impact on trade between more distant countries. We test this implication in two steps, relying on a broad range of real and financial transactions measures, as well as several different metrics of distance (physical, linguistic, and internet). We first show that during the Great Trade Collapse of 2007-09 international transactions fell more between countries that are more distant along the various metrics, and find that the different distance measures magnify each other’s respective impacts. We then focus on a longer panel analysis of trade in goods and show that trade is more volatile between more distant countries, with again a magnification pattern across metrics of distance.

No. 2251
21 March 2019
Labor share and growth in the long run

Abstract

JEL Classification

E24 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Employment, Unemployment, Wages, Intergenerational Income Distribution, Aggregate Human Capital

E25 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Aggregate Factor Income Distribution

N1 : Economic History→Macroeconomics and Monetary Economics, Industrial Structure, Growth, Fluctuations

Abstract

This paper establishes some stylized facts of the long run relationship between growth and labor shares using historical data for the United States (1898-2010), the United Kingdom (1856-2010), and France (1896-2010). Performing individual country time-frequency analysis, we demonstrate the existence of long-term cycles in labor share of thirty to fifty years explaining a major part of the variance in the data. Further, the impact of labor share on growth changes sign with the frequency considered from negative at high frequencies to positive at low frequencies. Finally, the positive coefficient associated with the labor share at low frequencies increases over time.

No. 2250
20 March 2019
Forecasting daily electricity prices with monthly macroeconomic variables

Abstract

JEL Classification

C11 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Bayesian Analysis: General

C53 : Mathematical and Quantitative Methods→Econometric Modeling→Forecasting and Prediction Methods, Simulation Methods

Q43 : Agricultural and Natural Resource Economics, Environmental and Ecological Economics→Energy→Energy and the Macroeconomy

Q47 : Agricultural and Natural Resource Economics, Environmental and Ecological Economics→Energy→Energy Forecasting

Abstract

We analyse the importance of macroeconomic information, such as industrial production index and oil price, for forecasting daily electricity prices in two of the main European markets, Germany and Italy. We do that by means of mixed-frequency models, introducing a Bayesian approach to reverse unrestricted MIDAS models (RU-MIDAS). We study the forecasting accuracy for different horizons (from 1 day ahead to 28 days ahead) and by considering different specifications of the models. We find gains around 20% at short horizons and around 10% at long horizons. Therefore, it turns out that the macroeconomic low frequency variables are more important for short horizons than for longer horizons. The benchmark is almost never included in the model confidence set.

No. 2249
18 March 2019
Whatever it takes: what’s the impact of a major nonconventional monetary policy intervention?

Abstract

JEL Classification

E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

F34 : International Economics→International Finance→International Lending and Debt Problems

Abstract

We assess how a major, unconventional central bank intervention, Draghi’s “whatever it takes” speech, affected lending conditions. Similar to other large interventions, it responded to adverse financial and macroeconomic developments that also influenced the supply and demand for credit. We avoid such endogeneity concerns by focusing on a third country and comparing lending conditions by euro area and other banks to the same borrower. We show that the intervention reversed prior risk-taking – in volume, price, and loan credit ratings – by subsidiaries of euro area banks relative to local and other foreign banks. Our results document a new effect of large central banks’ interventions and are robust along many dimensions.

No. 2248
12 March 2019
Global growth on life support? The contributions of fiscal and monetary policy since the global financial crisis

Abstract

JEL Classification

C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes

E42 : Macroeconomics and Monetary Economics→Money and Interest Rates→Monetary Systems, Standards, Regimes, Government and the Monetary System, Payment Systems

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

This paper compares the role of monetary and fiscal policy shocks in advanced and emerging economies. Using a model with a hierarchical structure we capture the variability of GDP response to policy shocks both between and within the groups of advanced and emerging countries. Our results provide evidence that fiscal policy effects are heterogeneous across countries, with higher multipliers in advanced economies compared to emerging markets, while monetary policy is found to have more homogeneous effects on GDP. We then quantify the policy contribution on GDP growth in the last decade by means of a structural counterfactual analysis based on conditional forecasts. We find that global GDP growth benefited from substantial policy support during the global financial crisis but policy tightening thereafter, particularly fiscal consolidation, acted as a significant drag on the subsequent global recovery. In addition we show that the role of policy has differed across countries. Specifically, in advanced economies, highly accommodative monetary policy has been counteracted by strong fiscal consolidation. By contrast, in emerging economies, monetary policy has been less accommodative since the global recession.

No. 2247
25 February 2019
The Green Golden Rule: habit and anticipation of future consumption

Abstract

JEL Classification

D90 : Microeconomics→Intertemporal Choice→General

Q56 : Agricultural and Natural Resource Economics, Environmental and Ecological Economics→Environmental Economics→Environment and Development, Environment and Trade, Sustainability, Environmental Accounts and Accounting, Environmental Equity, Population Growth

Abstract

We derive the Green Golden Rule (GGR) in the Habit Formation (HF) and Anticipation of Future Consumption (AFC) frameworks. Since consumption is the key variable of GGR, time non-separabilities in preferences over consumption streams, given by the AFC and HF, may have important impacts on the environment and sustainability. We demonstrate that agents who smooth their consumption patterns, according to the HF hypothesis, are more likely to preserve the environment than those who anticipate future consumption or who do not so smooth consumption.

No. 2246
22 February 2019
Mars or mercury redux: the geopolitics of bilateral trade agreements

Abstract

JEL Classification

F13 : International Economics→Trade→Trade Policy, International Trade Organizations

N20 : Economic History→Financial Markets and Institutions→General, International, or Comparative

Abstract

We analyze the role of economic and security considerations in bilateral trade agreements. We use the pre-World War I period to test whether trade agreements are governed by pecuniary factors, such as distance and other frictions measured by gravity covariates, or by geopolitical factors. While there is support for both hypotheses, we find that defense pacts boost the probability of trade agreements by as much as 20 percentage points. Our estimates imply that were the U.S. to alienate its geopolitical allies, the likelihood and benefits of successful bilateral agreements would fall significantly. Trade creation from an agreement between the U.S. and E.U. countries would decline by about 0.6 percent of total U.S. exports.

No. 2245
22 February 2019
The financial transmission of housing bubbles: evidence from Spain

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

How do housing bubbles affect other economic sectors? We show that in the presence of collateral constraints, a bubble initially raises housing credit demand and crowds out credit to non-housing firms. If the bubble lasts, however, housing credit repayments raise banks’ net worth and expand credit supply, so that crowding-out eventually gives way to crowding-in. This is consistent with evidence from the recent Spanish housing bubble. Initially, credit growth of non-housing firms was lower at banks with higher bubble exposure, and firms relying on these banks exhibited lower credit and output growth. During the bubble’s last years, these effects reversed.

No. 2244
18 February 2019
Credit, financial conditions and the business cycle in China

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers

E17 : Macroeconomics and Monetary Economics→General Aggregative Models→Forecasting and Simulation: Models and Applications

Abstract

This paper presents empirical evidence of the role of financial conditions in China’s business cycle. We estimate a Bayesian-VAR for the Chinese economy, incorporating a financial conditions index for China that captures movements across a range of financial variables, including interest rates and interbank spreads, bond returns, and credit and equity flows. We impose sign restrictions on the impulse response functions to identify shocks to financial conditions and shocks to monetary policy. The model suggests that monetary policy, credit and financial conditions have played an important role in shaping China’s business cycle. Using conditional scenarios, we examine the role of credit in shaping economic outcomes in China over the past decade. Those scenarios underscore the important role of credit growth in supporting activity during the past decade, particularly the surge in credit following the global financial crisis in 2008. The financial tightening since the end of 2016 has contributed to a modest slowing of credit growth and activity.

No. 2243
18 February 2019
Monetary policy transmission to mortgages in a negative interest rate environment

Abstract

JEL Classification

E40 : Macroeconomics and Monetary Economics→Money and Interest Rates→General

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

Do negative policy rates hinder banks’ transmission of monetary policy? To answer this question, we examine the behaviour of Italian mortgage lenders using a novel loan-level dataset. When policy rates turn negative, banks with higher ratios of retail overnight deposits to total assets charge more on new fixed rate mortgages. This suggests that the funding structure of banks may matter for the transmission of negative policy rates, especially for long-maturity illiquid assets. Nevertheless, the aggregate economic implications for households are small, suggesting that concerns about inefficient monetary policy transmission to households under modestly negative rates are likely overstated.

No. 2242
15 February 2019
The anatomy of the euro area interest rate swap market

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

Abstract

Using a novel regulatory dataset of fully identified derivatives transactions, this paper provides the first comprehensive analysis of the structure of the euro area interest rate swap (IRS) market after the start of the mandatory clearing obligation. Our dataset contains 1.7 million bilateral IRS transactions of banks and non-banks. Our key results are as follows: 1) The euro area IRS market is highly standardised and concentrated around the group of the G16 Dealers but also around a significant group of core ”intermediaries" (and major CCPs). 2) Banks are active in all segments of the IRS euro market, whereas non-banks are often specialised. 3) When using relative net exposures as a proxy for the “flow of risk" in the IRS market, we find that risk absorption takes place in the core as well as the periphery of the network. 4) Among the Basel III capital and liquidity ratios, the leverage ratio plays a key role in determining a bank's IRS trading activity. 5) Also, after mandatory central clearing, there is still a large dispersion in IRS transaction prices, which is partly determined by bank characteristics, such as the leverage ratio.

No. 2241
15 February 2019
Debt overhang, rollover risk, and corporate investment: evidence from the European crisis

Abstract

JEL Classification

E22 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Capital, Investment, Capacity

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

F34 : International Economics→International Finance→International Lending and Debt Problems

F36 : International Economics→International Finance→Financial Aspects of Economic Integration

G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill

Abstract

We quantify the role of financial factors behind the sluggish post-crisis performance of European firms. We use a firm-bank-sovereign matched database to identify separate roles for firm and bank balance sheet weaknesses arising from changes in sovereign risk and aggregate demand conditions. We find that firms with higher debt levels and a higher share of short-term debt reduce their investment more after the crisis. This negative effect is stronger for firms linked to weak banks with exposures to sovereign risk, signifying increased rollover risk. These financial channels explain about 60% of the decline in aggregate corporate investment.

No. 2240
14 February 2019
Breaking the shackles: Zombie firms, weak banks and depressed restructuring in Europe

Abstract

JEL Classification

D24 : Microeconomics→Production and Organizations→Production, Cost, Capital, Capital, Total Factor, and Multifactor Productivity, Capacity

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

L25 : Industrial Organization→Firm Objectives, Organization, and Behavior→Firm Performance: Size, Diversification, and Scope

O47 : Economic Development, Technological Change, and Growth→Economic Growth and Aggregate Productivity→Measurement of Economic Growth, Aggregate Productivity, Cross-Country Output Convergence

Abstract

This paper explores the connection between ”zombie” firms (firms that would typically exit in a competitive market) and bank health and the consequences for aggregate productivity in 11 European countries. Controlling for cyclical effects, the results show that zombie firms are more likely to be connected to weak banks, suggesting that the zombie firm problem in Europe may at least partly stem from bank forbearance. The increasing survival of zombie firms congests markets and constrains the growth of more productive firms, to the detriment of aggregate productivity growth. Our results suggest that around one-third of the impact of zombie congestion on capital misallocation can be directly attributed to bank health and additional analysis suggests that this may partly be due to reduced availability of credit to healthy firms. Finally, improvements in bank health are more likely to be associated with a reduction in the prevalence of zombie firms in countries where insolvency regimes do not unduly inhibit corporate restructuring. Thus, leveraging the important complementarities between bank strengthening efforts and insolvency regime reform would contribute to breaking the shackles on potential growth in Europe.

No. 2239
13 February 2019
Money markets, collateral and monetary policy

Abstract

JEL Classification

G10 : Financial Economics→General Financial Markets→General

G20 : Financial Economics→Financial Institutions and Services→General

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

Abstract

Interbank money markets have been subject to substantial impairments in the recent decade, such as a decline in unsecured lending and substantial increases in haircuts on posted collateral. This paper seeks to understand the implications of these developments for the broader economy and monetary policy. To that end, we develop a novel general equilibrium model featuring heterogeneous banks, interbank markets for both secured and unsecured credit, and a central bank. The model features a number of occasionally binding constraints. The interactions between these constraints - in particular leverage and liquidity constraints - are key in determining macroeconomic outcomes. We find that both secured and unsecured money market frictions force banks to either divert resources into unproductive but liquid assets or to de-lever, which leads to less lending and output. If the liquidity constraint is very tight, the leverage constraint may turn slack. In this case, there are large declines in lending and output. We show how central bank policies which increase the size of the central bank balance sheet can attenuate this decline.

No. 2238
13 February 2019
America First? A US-centric view of global capital flows

Abstract

JEL Classification

F15 : International Economics→Trade→Economic Integration

F21 : International Economics→International Factor Movements and International Business→International Investment, Long-Term Capital Movements

F36 : International Economics→International Finance→Financial Aspects of Economic Integration

F42 : International Economics→Macroeconomic Aspects of International Trade and Finance→International Policy Coordination and Transmission

G15 : Financial Economics→General Financial Markets→International Financial Markets

Abstract

Both academic researchers and policymakers posit a unique role for the US in the inter-national financial system. This paper investigates the characteristics and determinants of US cross-border financial flows and examines how these contrast with those of the rest of the world. We analyse the relative importance of US, country-specific, and global variables as determinants of aggregate and bilateral US financial flows and as determinants of country-level cross-border financial flows excluding those directly involving the US. Our results indicate that variation in US variables – notably the VIX and US dollar exchange rate – has a quantitatively important influence on global financial flows, but mostly via US cross-border flows. Global and national risk indicators perform better in explaining “rest of the world” flows. Moreover, we find that the correlation between US and rest of the world flows peaks in periods of elevated uncertainty. We interpret our findings as evidence for the existence of a global financial cycle, only some of which is driven by policies and events in the US.

No. 2237
7 February 2019
Empowering central bank asset purchases: The role of financial policies

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

F40 : International Economics→Macroeconomic Aspects of International Trade and Finance→General

Abstract

This paper contributes to the debate on the macroeconomic effectiveness of expansionary non-standard monetary policy measures in a regulated banking environment. Based on an estimated DSGE model, we explore the interactions between central bank asset purchases and bank capital-based financial policies (regulatory, supervisory or macroprudential) through its influence on bank risk-shifting motives. We find that weakly-capitalised banks display excessive risk-taking which reinforces the credit easing channel of central bank asset purchases, at the cost of higher bank default probability and risks to financial stability. In such a case, adequate bank capital demand through higher minimum capital requirements curtails the excessive credit origination and restores a more efficient propagation of central bank asset purchases. As supervisors can formulate further capital demands, uncertainty about the supervisory oversight provokes precautionary motives for banks. They build-up extra capital buffer attenuating non-standard monetary policy. Finally, in a weakly-capitalised banking system, countercyclical macroprudential policy attenuates banks risk-taking and dampens the excessive persistence of the non-standard monetary policy impulse. On the contrary, in a well-capitalised banking system, macroprudential policy should look through the effects of central bank asset purchases on bank capital position, as the costs in terms of macroeconomic stabilisation seem to outweigh the marginal financial stability benefits.

No. 2236
7 February 2019
Do reputable issuers provide better-quality securitizations?

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

G24 : Financial Economics→Financial Institutions and Services→Investment Banking, Venture Capital, Brokerage, Ratings and Ratings Agencies

G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We examine the link between issuer reputation and mortgage-backed security (MBS) performance using a sample of 4,247 European MBS issued between 1999 and 2007. We measure performance with credit rating downgrades and delinquencies and track their changes over the long term. We find that, overall, MBS sold by reputable issuers are collateralised by higher quality asset pools which have lower delinquency rates and are less likely to be downgraded. However, as credit standards declined during the boom period of 2005-2007, asset pools securitized by reputable issuers were of worse quality compared to those securitized by less reputable issuers. Therefore, reputation as a self-disciplining mechanism failed to incentivise the production of high quality securities during the credit boom.

No. 2235
4 February 2019
The link between labor cost and price inflation in the euro area

Abstract

JEL Classification

C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes

E24 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Employment, Unemployment, Wages, Intergenerational Income Distribution, Aggregate Human Capital

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

Abstract

This paper documents, for the first time in a systematic manner, the link between labor cost and price inflation in the euro area. Using country and sector quarterly data over the period 1985Q1-2018Q1 we find a strong link between labor cost and price inflation in the four major economies of the euro area and across the three main sectors. The dynamic interaction between prices and wages is time-varying and depends on the state of the economy and on the shocks hitting the economy. Our results show that it is more likely that labor costs are passed on to price inflation with demand shocks than with supply shocks. However, the pass-through is systematically lower in periods of low inflation as compared to periods of high inflation. These results confirm that, under circumstances of predominantly demand shocks, labor cost increases will be passed on to prices. Coming from a period of low inflation, however, this pass-through could be moderate at least until inflation stably reaches a sustained path.

No. 2234
1 February 2019
Markets, banks, and shadow banks
ECB Lamfalussy Fellowship Programme

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We analyze the effect of bank capital requirements on the structure and risk of a financial system where markets, regulated banks, and shadow banks coexist. Banks face a moral hazard problem in screening entrepreneurs' projects, and they choose whether to be regulated or not. If regulated, a supervisor certifies their capital; if not, they have to rely on more expensive private certification. Under both risk-insensitive and risk-sensitive requirements, safer entrepreneurs borrow from the market and riskier entrepreneurs borrow from banks. But risk-insensitive (sensitive) requirements are especially costly for relatively safe (risky) entrepreneurs, which may shift from regulated to shadow banks.

No. 2233
31 January 2019
A dynamic model of bank behaviour under multiple regulatory constraints

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill

Abstract

We develop a dynamic structural model of bank behaviour that provides a microeconomic foundation for bank capital and liquidity structures and analyses the effects of changes in regulatory capital and liquidity requirements as well as their interaction. Our findings suggest that adjustments in both types of requirements can have an impact on loan supply, with considerable heterogeneity across banks and over time. The model illustrates that banks' reactions depend on initial balance sheet conditions and reconciles evidence on short-term reductions in loan supply with findings suggesting that better capitalized banks are better able to lend in the medium- to long-term.

No. 2232
31 January 2019
From cash- to securities-driven euro area repo markets: the role of financial stress and safe asset scarcity

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

C33 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Panel Data Models, Spatio-temporal Models

C38 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Classification Methods, Cluster Analysis, Principal Components, Factor Models

Abstract

Focussing on repo specialness premia, using ISIN-specific transaction-by-transaction data of one-day maturity repos, we document a gradual shift from cash- to securities-driven transactions in euro area repo markets over the period 2010-2018. Compared to earlier studies focussing only on specific sub-periods or market segments we extend, illustrate, and validate evidence on financial frictions that are relevant in driving repo premia: controlling for a comprehensive range of bond-market specific characteristics, we show that repo premia have been systematically affected by fragmentation in the sovereign space, bank funding stress, and safe asset scarcity. These channels exhibit very strong country-specific differences, as also reflected by large discrepancies in country-specific interest rates on General Collateral. To ensure robustness of our empirical findings, we apply panel econometric and data mining approaches in a complementary and mutually informative way.

No. 2231
30 January 2019
Do public wages in the euro area explain private wage developments? An empirical investigation

Abstract

JEL Classification

E24 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Employment, Unemployment, Wages, Intergenerational Income Distribution, Aggregate Human Capital

E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy

J30 : Labor and Demographic Economics→Wages, Compensation, and Labor Costs→General

C33 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Panel Data Models, Spatio-temporal Models

C11 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Bayesian Analysis: General

Abstract

This paper investigates the relationship between public and private wages in the five largest euro area countries for the period 1997-2017. The analysis shows that there exists a positive and significant response of private wages to a public wage shock. This effect is found to be temporary and to differ across countries (positive and significant in France, Spain, Italy and non-significant in Germany and the Netherlands). Interestingly, the response of private wages is found to be asymmetric: a positive and statistically significant response is found in case of a positive shock to public wages, while no statistically significant effects are detected in case of a cut to public wages. As the public wage containment policies adopted during the sovereign debt crisis are expected to be gradually lifted in several euro area countries, the findings of this paper suggest that knock-on effects on private sector wages cannot be excluded in the years to come.

No. 2230
30 January 2019
Some borrowers are more equal than others: bank funding shocks and credit reallocation

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

This paper provides evidence on the strategic lending decisions made by banks facing a negative funding shock. Using bank-firm level credit data, we show that banks reallocate credit within their loan portfolio in at least three different ways. First, banks reallocate to sectors where they have a high market share. Second, they also reallocate to sectors in which they are more specialized. Third, they reallocate credit towards low-risk firms. These reallocation effects are economically large. A standard deviation increase in sector market share, sector specialization or firm soundness reduces the transmission of the funding shock to credit supply by 22, 8 and 10%, respectively.

No. 2229
29 January 2019
Medium term treatment and side effects of quantitative easing: international evidence

Abstract

JEL Classification

E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit

F3 : International Economics→International Finance

Abstract

We use a cross-country sample of monthly observations for quantitative easing (QE) treatments in order to study the causal effect of such policies on a large set of economic and financial outcome variables. We address potential endogeneity by re-randomising the sample and applying the augmented inverse probability weighting (AIPW) estimator. Our results show that QE policies do affect the central bank balance sheet and asset prices, in particular long term yields, equity prices and exchange rates in the expected direction. Most importantly, we find that QE policies lead to a sustained rise in the CPI and in inflation expectations. However, our findings suggest that the main transmission channel does not appear to be stronger aggregate demand impacting inflation through the Phillips curve, but rather exchange rate depreciation. Finally, we do not find any evidence for side effects and increases in risk taking following QE, with real house prices and real credit not increasing or falling, and no downward effect on stock market volatility.

No. 2228
28 January 2019
When losses turn into loans: the cost of undercapitalized banks
ECB Lamfalussy Fellowship Programme

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

G38 : Financial Economics→Corporate Finance and Governance→Government Policy and Regulation

E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers

D24 : Microeconomics→Production and Organizations→Production, Cost, Capital, Capital, Total Factor, and Multifactor Productivity, Capacity

O47 : Economic Development, Technological Change, and Growth→Economic Growth and Aggregate Productivity→Measurement of Economic Growth, Aggregate Productivity, Cross-Country Output Convergence

Abstract

We provide evidence that a weak banking sector has contributed to low productivity growth following the European sovereign debt crisis. An unexpected increase in capital requirements for a subset of Portuguese banks in 2011 provides a natural experiment to study the effects of reduced bank capital adequacy on productivity. Affected banks respond not only by cutting back on lending but also by reallocating credit to firms in financial distress with prior underreported loan loss provisioning. We develop a method to detect when banks delay loss reporting using detailed loan-level data. We then show that the credit reallocation leads to a reallocation of production factors across rms. A partial equilibrium exercise suggests that the resulting increase in factor misallocation accounts for 20% of the decline in productivity in Portugal in 2012.

No. 2227
28 January 2019
Mind the gap: a multi-country BVAR benchmark for the Eurosystem projections

Abstract

JEL Classification

C52 : Mathematical and Quantitative Methods→Econometric Modeling→Model Evaluation, Validation, and Selection

C53 : Mathematical and Quantitative Methods→Econometric Modeling→Forecasting and Prediction Methods, Simulation Methods

E37 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Forecasting and Simulation: Models and Applications

Abstract

The Eurosystem staff forecasts are conditional on the financial markets, the global economy and fiscal policy outlook, and include expert judgement. We develop a multi-country BVAR for the four largest countries of the euro area and we show that it provides accurate conditional forecasts of policy relevant variables such as, for example, consumer prices and GDP. The forecasting accuracy and the ability to mimic the path of the Eurosystem projections suggest that the model is a valid benchmark to assess the consistency of the projections with the conditional assumptions. As such, the BVAR can be used to identify possible sources of judgement, based on the gaps between the Eurosystem projections and the historical regularities captured by the model.

No. 2226
25 January 2019
Money, credit, monetary policy and the business cycle in the euro area: what has changed since the crisis?

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes

C51 : Mathematical and Quantitative Methods→Econometric Modeling→Model Construction and Estimation

Abstract

This paper studies the relationship between the business cycle and financial intermediation in the euro area. We establish stylized facts and study their stability during the global financial crisis and the European sovereign debt crisis. Long-term interest rates have been exceptionally high and long-term loans and deposits exceptionally low since the Lehman collapse. Instead, short-term interest rates and short-term loans and deposits did not show abnormal dynamics in the course of the financial and sovereign debt crisis.

No. 2225
25 January 2019
Risk endogeneity at the lender/investor-of-last-resort

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

C33 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Panel Data Models, Spatio-temporal Models

Abstract

We address the question to what extent a central bank can de-risk its balance sheet by unconventional monetary policy operations. To this end, we propose a novel risk measurement framework to empirically study the time-variation in central bank portfolio credit risks associated with such operations. The framework accommodates a large number of bank and sovereign counterparties, joint tail dependence, skewness, and time-varying dependence parameters. In an application to selected items from the consolidated Eurosystem's weekly balance sheet between 2009 and 2015, we find that unconventional monetary policy operations generated beneficial risk spill-overs across monetary policy operations, causing overall risk to be nonlinear in exposures. Some policy operations reduced rather than increased overall risk.

No. 2224
16 January 2019
CoMap: mapping contagion in the euro area banking sector

Abstract

JEL Classification

D85 : Microeconomics→Information, Knowledge, and Uncertainty→Network Formation and Analysis: Theory

G17 : Financial Economics→General Financial Markets→Financial Forecasting and Simulation

G33 : Financial Economics→Corporate Finance and Governance→Bankruptcy, Liquidation

L14 : Industrial Organization→Market Structure, Firm Strategy, and Market Performance→Transactional Relationships, Contracts and Reputation, Networks

Abstract

This paper presents a novel approach to investigate and model the network of euro area banks’ large exposures within the global banking system. Drawing on a unique dataset, the paper documents the degree of interconnectedness and systemic risk of the euro area banking system based on bilateral linkages. We then develop a Contagion Mapping (CoMap) methodology to study contagion potential of an exogenous default shock via counterparty credit and funding risks. We construct contagion and vulnerability indices measuring respectively the systemic importance of banks and their degree of fragility. Decomposing the results into the respective contributions of credit and funding shocks provides insights to the nature of contagion which can be used to calibrate bank-specific capital and liquidity requirements and large exposures limits. We find that tipping points shifting the euro area banking system from a less vulnerable state to a highly vulnerable state are a non-linear function of the combination of network structures and bank-specific characteristics.

No. 2223
16 January 2019
Leaning against the wind: macroprudential policy and the financial cycle

Abstract

JEL Classification

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

G01 : Financial Economics→General→Financial Crises

Abstract

Should monetary policy lean against financial stability risks? This has been a subject of fierce debate over the last decades. We contribute to the debate about “leaning against the wind” (LAW) along three lines. First, we evaluate the cost and benefits of LAW using the Svensson (2017) framework for the euro area and find that the costs outweigh the benefits. Second, we extend the framework to address a critique that Svensson does not consider the lower frequency financial cycle. Third, we use this extended framework to assess the costs and benefits of monetary and macroprudential policy. We find that macroprudential policy has net marginal benefits in addressing risks to financial stability in the euro area, whereas monetary policy has net marginal costs. This would suggest that an active use of macroprudential policies targeting financial stability risks would alleviate the burden on monetary policy to “lean against the wind”.

No. 2222
15 January 2019
On the retirement effect of inheritance: heterogeneity and the role of risk aversion

Abstract

JEL Classification

J14 : Labor and Demographic Economics→Demographic Economics→Economics of the Elderly, Economics of the Handicapped, Non-Labor Market Discrimination

J26 : Labor and Demographic Economics→Demand and Supply of Labor→Retirement, Retirement Policies

Abstract

This paper provides new insights on the effect of inheritance receipt on retirement. We build on lifelong information on inheritances received and labor market transitions available for respondents of the French Wealth Survey. This feature allows us to compare current retirement rates among current and future inheritors. Chances of current retirement are 40% higher among current inheritors than among individuals who will inherit in the next two years, but there is substantial heterogeneity in this effect across socio-demographic groups. The effect is also stronger for individuals with a higher risk aversion, which we interpret with a simple theoretical model.

No. 2221
15 January 2019
Interest rates and foreign spillovers

Abstract

JEL Classification

C3 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables

G2 : Financial Economics→Financial Institutions and Services

Abstract

We show that medium-term interest rates in the euro area, Japan, UK and US are affected by domestic and foreign shocks. We find that US rates are the main source of spillovers globally and are less exposed to foreign shocks. Foreign spillovers to European rates were negligible only during the sovereign debt crisis and the introduction of more aggressive monetary policies by the ECB. We identify causal relations among asset prices through structural vector autoregressions (SVAR) and magnitude restrictions. We use preliminary regressions on event days to estimate key parameters employed to constrain the structural parameter space of the SVAR.

No. 2220
11 January 2019
Attenuating the forward guidance puzzle: implications for optimal monetary policy

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination

Abstract

We examine the implications of less powerful forward guidance for optimal policy using a sticky-price model with an effective lower bound (ELB) on nominal interest rates as well as a discounted Euler equation and Phillips curve. When the private-sector agents discount future economic conditions more in making their decisions today, an announced cut in future interest rates becomes less effective in stimulating current economic activity. While the implication of such discounting for optimal policy depends on its degree, we find that, under a wide range of plausible degrees of discounting, it is optimal for the central bank to compensate for the reduced effect of a future rate cut by keeping the policy rate at the ELB for longer.

Disclaimer: Please keep in mind that the papers are published in the name of the author(s). Their views do not necessarily reflect those of the ECB.