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.

Availability: ECB Working Papers are available online only, get updated on latest Working Paper releases by RSS news feed.

No. 2187
16 October 2018
Is the top tail of the wealth distribution the missing link between the Household Finance and Consumption Survey and national accounts?

Abstract

JEL Classification

C46 : Mathematical and Quantitative Methods→Econometric and Statistical Methods: Special Topics→Specific Distributions, Specific Statistics

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

E01 : Macroeconomics and Monetary Economics→General→Measurement and Data on National Income and Product Accounts and Wealth, Environmental Accounts

Abstract

The financial accounts of the household sector within the system of national accounts report the aggregate asset holdings and liabilities of all households within a country. In principle, when household wealth surveys are explicitly designed to be representative of all households, aggregating these micro data should correspond to the macro aggregates. In practice, however, differences are large. We first discuss conceptual and generic differences between those two sources of data. Thereafter we investigate missing top tail observation from wealth surveys as a source of discrepancy. By fitting a Pareto distribution to the upper tail, we provide an estimate of how much of the gap between the micro and macro data is caused by the underestimation of the top tail of the wealth distribution. Conceptual and generic differences as well as missing top tail observations explain part of the gap between financial accounts and survey aggregates.

No. 2186
16 October 2018
Interest rate spreads and forward guidance

Abstract

JEL Classification

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

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

We provide evidence that liquidity premia on assets that are more relevant for private agents’ intertemporal choices than near-money assets increase in response to expansionary forward guidance announcements. We introduce a structural specification of liquidity premia based on assets’ differential pledgeability to a basic New Keynesian model to replicate this finding. This model predicts that output and inflation effects of forward guidance do not increase with the length of the guidance period and are substantially smaller than if liquidity premia were neglected. This indicates that there are no puzzling forward guidance effects when endogenous liquidity premia are taken into account.

No. 2185
15 October 2018
Beyond spreads: measuring sovereign market stress in the euro area

Abstract

JEL Classification

C43 : Mathematical and Quantitative Methods→Econometric and Statistical Methods: Special Topics→Index Numbers and Aggregation

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

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

G01 : Financial Economics→General→Financial Crises

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

Abstract

In this paper we propose a composite indicator that measures multidimensional sovereign bond market stress in the euro area as a whole and in individual euro area member states. It integrates measures of credit risk, volatility and liquidity at short-term and long-term bond maturities into a broad measure of sovereign market stress. The statistical framework builds on that of the ECB’s Composite Indicator of Systemic Stress (CISS) developed by Hollo, Kremer and Lo Duca (2012), so that we call our metric the Composite Indicator of Systemic Sovereign Stress or “SovCISS”. We implement the SovCISS for eleven euro area member states and also present four options of a SovCISS for the entire monetary union. In addition, we suggest a linear decomposition of the SovCISS, singling out contributions of the different components and of the time-varying correlations across these components. Comparing develoments in the SovCISS and the CISS over the crisis period clearly illustrates the usefulness of the latter for the real-time monitoring of systemic instabilities in the financial system as a whole. Finally, an application of the country-specific SovCISS indicators to the VAR-based spillover literature suggests that stress mainly originates from a few euro area countries, and that spillover patterns vary over time.

No. 2184
12 October 2018
Trust and the household-bank relationship

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

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

Abstract

We examine the role of trust in households’ decisions to hold a bank account and to switch to a new bank. We explore Italian household-level data that contain restricted information on the banks that the households are doing business with, as well as measures of trust in the households’ main bank and the banking sector. We find that households who distrust the banking sector are less likely to hold a bank account. Moreover, account holders are more likely to switch to a new main bank if they do not trust their current one. The estimated relationships persist over and above a range of socioeconomic variables.

No. 2183
12 October 2018
(Un)conventional policy and the effective lower bound

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

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 study the optimal combination of conventional (interest rates) and unconventional (credit easing) monetary policy in a model where agency costs generate a spread between deposit and lending rates. We show that unconventional measures can be a powerful substitute for interest rate policy in the face of certain financial shocks. Such measures help shield the real economy from the deterioration in financial conditions and warrant smaller reductions in interest rates. They therefore lower the likelihood of hitting the lower bound constraint. The alternative option to cut interest rates more deeply and avoid deploying unconventional measures is sub-optimal, as it would induce unnecessarily large changes in savers’ intertemporal consumption patterns.

No. 2182
11 October 2018
A framework for early-warning modeling with an application to banks

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises

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

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

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

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

C54 : Mathematical and Quantitative Methods→Econometric Modeling→Quantitative Policy Modeling

Abstract

This paper proposes a framework for deriving early-warning models with optimal out-of-sample forecasting properties and applies it to predicting distress in European banks. The main contributions of the paper are threefold. First, the paper introduces a conceptual framework to guide the process of building early-warning models, which highlights and structures the numerous complex choices that the modeler needs to make. Second, the paper proposes a flexible modeling solution to the conceptual framework that supports model selection in real-time. Specifically, our proposed solution is to combine the loss function approach to evaluate early-warning models with regularized logistic regression and cross-validation to find a model specification with optimal real-time out-of-sample forecasting properties. Third, the paper illustrates how the modeling framework can be used in analysis supporting both microand macro-prudential policy by applying it to a large dataset of EU banks and showing some examples of early-warning model visualizations.

No. 2181
2 October 2018
A structural model to assess the impact of bank capitalization changes conditional on a bail-in versus bail-out regime

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

H81 : Public Economics→Miscellaneous Issues→Governmental Loans, Loan Guarantees, Credits, Grants, Bailouts

Abstract

We develop a structural model for valuing bank balance sheet components such as the equity and debt value, the value for the government when the bank is operated by private shareholders including the present value of a possible future bailout, the bailout value incurred by the government following the abandonment of the private shareholders, and, moreover, some price and risk parameters, including the funding cost spread and the banks’ probability of default. The structural model implies an abandonment threshold, at which if total income drops below this threshold, private shareholders abandon the bank. In this case, the shareholders lose part (or all) of the capital that they hold in the bank, the creditors lose part or all of their debt, and the government receives a portion (or all) of the capital and all of the debt that is not recovered by creditors. Hence, we assume that part of the capital can be lost due to financial distress or to cover bankruptcy costs. We use the model framework to assess the impact of capital-based macro-prudential policy measures and focus in particular on assessing the difference that an assumed bail-in as opposed to bail-out regime can make.

No. 2180
26 September 2018
The role of factor substitution and technical progress in China's great expansion

Abstract

JEL Classification

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

E13 : Macroeconomics and Monetary Economics→General Aggregative Models→Neoclassical

O11 : Economic Development, Technological Change, and Growth→Economic Development→Macroeconomic Analyses of Economic Development

Abstract

We offer a macroeconomic assessment of China’s Reform Period, highlighting several neglected channels underlining its great expansion. Estimating the supply side of the post-Reform economy reveals the relatively high (above unity) value of the elasticity of factor substitution and the time-varying pattern of factor-saving technical change. The latter we relate to trade, human capital and reallocation factors. We then demonstrate how, in addition to factor accumulation and technical progress, the above-unity elasticity of substitution can be a source of growth (the ‘de La Grandville hypothesis’). We then draw upon our estimated framework to rationalize China’s high and rising savings ratio as well as the dynamic nature of its convergence path.

No. 2179
25 September 2018
The global effects of global risk and uncertainty

Abstract

JEL Classification

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

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

F65 : International Economics→Economic Impacts of Globalization→Finance

Abstract

In this paper, we analyse the effects of a shock to global financial uncertainty and risk aversion on real economic activity. To this end, we extract a global factor, which explains approximately 40% of the variance of about 1000 risky asset returns from around the world. We then study how shocks to the factor affect economic activity in 36 advanced and emerging small open economies by estimating local projections in a panel regression framework. We find the output responses to be quite heterogeneous across countries but, in general, negative and persistent. Furthermore, the effects of shocks to the global factor are stronger in countries with a higher degree of trade and/or financial openness, as well as in countries with higher levels of external debt, less developed financial sectors, and higher risk rating.

No. 2178
25 September 2018
Revenue- versus spending-based consolidation plans: the role of follow-up

Abstract

JEL Classification

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

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

H5 : Public Economics→National Government Expenditures and Related Policies

Abstract

The literature on fiscal multipliers finds that spending-based fiscal consolidations tend to have more benign macro-economic consequences than revenue-based consolidations. By directly comparing expost data with consolidation plans, we present evidence of a systematically weaker follow-up of spending-based consolidation plans. Next, using a newly-developed dataset of consolidation announcements, panel VAR regressions confirm the weaker follow-up of spending-based plans and their more benign macro-economic effects compared to those of revenue-based plans. We disentangle the role of the difference in follow-up from that of the difference in the composition of revenue- and spending-based consolidations. While the latter channel, which works through the difference between revenue and spending multipliers, explains the largest fraction of the difference in economic trajectories, the difference in follow-up plays a non-negligible role as well.

No. 2177
24 September 2018
Managing the sovereign-bank nexus
Discussion papers

Abstract

JEL Classification

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

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

G01 : Financial Economics→General→Financial Crises

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

Abstract

This paper identifies the various channels that give rise to a “sovereign-bank nexus” whereby the financial health of banks and sovereigns is intertwined. We find that banks and sovereigns are linked by three interacting channels: banks hold large amounts of sovereign debt; banks are protected by government guarantees; and the health of banks and governments affect and is affected by economic activity. Evidence suggests that all three channels are relevant. The paper concludes with a discussion of the policy implications of these findings.

No. 2176
24 September 2018
Who bears interest rate risk?

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

We study the allocation of interest rate risk within the European banking sector using novel data. Banks’ exposure to interest rate risk is small on aggregate, but heterogeneous in the cross-section. In contrast to conventional wisdom, net worth is increasing in interest rates for approximately half of the institutions in our sample. Cross-sectional variation in banks’ exposures is driven by cross-country differences in loan-rate fixation conventions for mortgages. Banks use derivatives to partially hedge on-balance sheet exposures. Residual exposures imply that changes in interest rates have redistributive effects within the banking sector.

No. 2175
14 September 2018
ALICE: A new inflation monitoring tool

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

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

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

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

Abstract

This paper develops Area-wide Leading Inflation CyclE (ALICE) indicators for euro area headline and core inflation with an aim to provide early signals about turning points in the respective inflation cycle. The series included in the two composite leading indicators are carefully selected from around 160 candidate leading series using a general-to-specific selection process. The headline ALICE includes nine leading series and has a lead time of 3 months while the core ALICE consists of seven series and leads the reference cycle by 4 months. The lead times of the indicators increase to 5 and 9 months, respectively, based on a subset of the selected leading series with longer leading properties. Both indicators identify main turning points in the inflation cycle ex post and perform well in a simulated real-time exercise over the period from 2010 to the beginning of 2018. They also have performed well in forecasting the direction of inflation. In terms of the quantitative forecast accurracy, the headline ALICE has on average performed broadly similarly to the Euro Zone Barometer survey, slightly worse than the Eurosystem/ECB Staff macroeconomic projections and better than the Random Walk model, albeit this is not the case for the core ALICE.

No. 2174
1 August 2018
Stochastic discounting and the transmission of money supply shocks

Abstract

JEL Classification

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

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

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

Abstract

This paper studies the effects of money supply shocks in a general equilibrium model that reproduces a term premium of the magnitude observed in the data. In an environment where financial frictions are the main source of monetary non-neutrality, I find that money supply shocks are less effective at stimulating inflation in recessions than in expansions. In terms of quantitative magnitude, the impact effect on inflation of a money supply shock is about half as large during recessions than during booms. This state dependence is essentially due to the time-variation in stochastic discounting that is needed to match the data.

No. 2173
1 August 2018
Life below zero: bank lending under negative policy rates

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

G20 : Financial Economics→Financial Institutions and Services→General

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

Abstract

We show that negative policy rates affect the supply of bank credit in a novel way. Banks are reluctant to pass on negative rates to depositors, which increases the funding cost of high-deposit banks, and reduces their net worth, relative to low-deposit banks. As a consequence, the introduction of negative policy rates by the European Central Bank in mid-2014 leads to more risk taking and less lending by euro-area banks with greater reliance on deposit funding. Our results suggest that negative rates are less accommodative, and could pose a risk to financial stability, if lending is done by high-deposit banks.

No. 2172
27 July 2018
International spillovers of quantitative easing

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

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

Abstract

This paper develops a two-country model with asset market segmentation to investigate the effects of quantitative easing implemented by the major central banks on a typical small open economy that follows independent monetary policy. The model is able to replicate the key empirical facts on emerging countries’ response to large scale asset purchases conducted abroad, including inflow of capital to local sovereign bond markets and an increase in international comovement of term premia. According to our simulations, quantitative easing abroad boosts domestic demand in the small economy, but undermines its international competitiveness and depresses aggregate output, at least in the short run. This is in contrast to conventional monetary easing in the large economy, which has positive spillovers to output in other countries. We also find that limiting these spillovers might require policies that affect directly international capital flows, like imposing capital controls or mimicking quantitative easing abroad by purchasing local long-term bonds.

No. 2171
27 July 2018
A methodology for automised outlier detection in high-dimensional datasets: an application to euro area banks' supervisory data

Abstract

JEL Classification

C18 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Methodological Issues: General

C81 : Mathematical and Quantitative Methods→Data Collection and Data Estimation Methodology, Computer Programs→Methodology for Collecting, Estimating, and Organizing Microeconomic Data, Data Access

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

Abstract

Outlier detection in high-dimensional datasets poses new challenges that have not been investigated in the literature. In this paper, we present an integrated methodology for the identification of outliers which is suitable for datasets with higher number of variables than observations. Our method aims to utilise the entire relevant information present in a dataset to detect outliers in an automatized way, a feature that renders the method suitable for application in large dimensional datasets. Our proposed five-step procedure for regression outlier detection entails a robust selection stage of the most explicative variables, the estimation of a robust regression model based on the selected variables, and a criterion to identify outliers based on robust measures of the residuals' dispersion. The proposed procedure deals also with data redundancy and missing observations which may inhibit the statistical processing of the data due to the ill-conditioning of the covariance matrix. The method is validated in a simulation study and an application to actual supervisory data on banks’ total assets.

No. 2170
18 July 2018
Monetary policy and household inequality
Discussion papers

Abstract

JEL Classification

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

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

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

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

This paper considers how monetary policy produces heterogeneous effects on euro area households, depending on the composition of their income and on the components of their wealth. We first review the existing evidence on how monetary policy affects income and wealth inequality. We then illustrate quantitatively how various channels of transmission — net interest rate exposure, inter-temporal substitution and indirect income channels — affect individual euro area households. We find that the indirect income channel has an overwhelming importance, especially for households holding few or no liquid assets. The indirect income channel is therefore also a substantial driver of changes in consumption at the aggregate level.

No. 2169
13 July 2018
Benefits and costs of liquidity regulation
Discussion papers

Abstract

JEL Classification

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

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

This paper investigates the costs and benefits of liquidity regulation. We find that liquidity tools are beneficial but cannot completely remove the need for Lender of Last Resort (LOLR) interventions by the central bank. Full compliance with current Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) rules would have reduced banks’ reliance on publicly provided liquidity during the global financial crisis without removing such assistance altogether. The paper also investigates the output costs of introducing the LCR and NSFR using two macro-financial models. We find these costs to be modest.

No. 2168
11 July 2018
The natural rate of interest and the financial cycle

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

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

Abstract

I extend the model of Laubach and Williams (2003) by introducing an explicit role for the financial cycle in the joint estimation of the natural rates of interest, unemployment and output, and the sustainable growth rate of the US economy. By incorporating the financial cycle – arguably an omitted variable from the system – the model is able to deliver more plausible estimates of business cycle dynamics. The sustained decline in the natural rate of interest in recent decades is confirmed, but I estimate that strong and persistent headwinds due to financial deleveraging have lowered temporarily the natural rate on average by around 1 p.p. below its long-run trend over 2008-14. This may have impaired the effectiveness of interest rate cuts to stimulate the economy and lift inflation back to target in the immediate aftermath of the GFC.

No. 2167
11 July 2018
Financial frictions, international capital flows and welfare
ECB Lamfalussy Fellowship Programme

Abstract

JEL Classification

D53 : Microeconomics→General Equilibrium and Disequilibrium→Financial Markets

E2 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy

F3 : International Economics→International Finance

Abstract

The connection between the financial crisis and global imbalances is controversial. This paper argues that this relationship is likely to be connected to the existence of heterogenous financial frictions in different domestic credit markets. By developing a general equilibrium model where adverse selection and limited pledgeability coexist, this work highlights why adverse selection may play a pivotal role in determining the different (often opposing) welfare effects of international capital flows on originating and destination countries. This perspective also advances an analytical framework that is flexible enough to analyze the global effects on investment allocation of the ”Saving Glut”, of the policies facilitating financial integration and macro-prudential policy.

No. 2166
3 July 2018
Credit shocks, employment protection, and growth: firm-level evidence from Spain

Abstract

JEL Classification

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

J80 : Labor and Demographic Economics→Labor Standards: National and International→General

D20 : Microeconomics→Production and Organizations→General

Abstract

We offer new evidence on the real effects of credit shocks in the presence of employment protection regulations by exploiting a unique provision in Spanish labor laws: dismissal rules are less stringent for Spanish firms with fewer than 50 employees, lowering the cost of hiring new workers. Using a new dataset, we find that during the financial crisis, healthy firms with fewer than 50 employees borrowing from troubled banks grew faster in sectors where capital and labor were sufficiently substitutable. This result does not obtain when we use a different cut-off for Spain or the same cut-off for firms in Germany. Our evidence suggests that labor market flexibility can dampen the negative effect of credit shocks by allowing firms to keep growing by substituting labor for capital.

No. 2165
25 June 2018
Proposal on ELBE and LGD in-default: tackling capital requirements after the financial crisis

Abstract

JEL Classification

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

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

Following the financial crisis, the share of non-performing loans has significantly increased, while the regulatory guidelines on the Internal-Ratings Based (IRB) approach for capital adequacy calculation related to defaulted exposures remains too general. As a result, the high-risk nature of these portfolios is clearly in danger of being managed in a heterogeneous and inappropriate manner by those financial institutions permitted to use the IRB system, with the consequent undue variability of Risk-Weighted Assets (RWA). This paper presents a proposal to construct Advanced IRB models for defaulted exposures, in line with current regulations, that preserve the risk sensitivity of capital requirements. To do so, both parameters Expected Loss Best Estimate (ELBE) and Loss Given Default (LGD) in-default are obtained, backed by an innovative indicator (Mixed Adjustment Indicator) that is introduced to ensure an appropriate estimation of expected and unexpected losses. The methodology presented has low complexity and is easily applied to the databases commonly used at these institutions, as illustrated by two examples.

No. 2164
21 June 2018
I will survive. Pricing strategies of financially distressed firms

Abstract

JEL Classification

C25 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Discrete Regression and Qualitative Choice Models, Discrete Regressors, Proportions

C26 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Instrumental Variables (IV) Estimation

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

L11 : Industrial Organization→Market Structure, Firm Strategy, and Market Performance→Production, Pricing, and Market Structure, Size Distribution of Firms

Abstract

We consider a standard result of customer market theory: if firms have stable customer relations and face financial frictions, they may keep prices relatively high on their locked-in shoppers to maintain short-term profits at the expense of future market shares in times of low demand and vice versa in times of high demand. We extend this theoretical framework so that the countercyclical behaviour of price margins is strengthened by the expected persistence of demand and the procyclicality of competitive pressures. We test these predictions for Italian firms participating in the 2014 Wage Dynamics Network Survey. All things being equal, financially constrained firms charge higher markups when faced with low demand; this behaviour is more evident when demand is perceived as being persistent. Our findings suggest that the severity of financial constraints in Italy was one of the causes of the sustained growth of prices in 2010-2013.

No. 2163
21 June 2018
Missing the wealthy in the HFCS: micro problems with macro implications

Abstract

JEL Classification

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

E01 : Macroeconomics and Monetary Economics→General→Measurement and Data on National Income and Product Accounts and Wealth, Environmental Accounts

Abstract

Macroeconomic aggregates on households’ wealth have a long tradition and are widely used to analyse and compare economies, yet they do not provide any information about the distribution of assets and liabilities within the population. The Household Finance and Consumption Survey (HFCS) constitutes a rich source of micro data that can be used to link macro aggregates with distributional information to compile Distributional National Accounts for wealth. Computing aggregates from this survey usually yields much lower amounts than what is reported by macroeconomic statistics. An important source of this gap may be the lack of the wealthiest households in the HFCS. This article combines a semi-parametric Pareto model estimated from survey data and observations from rich lists with a stratification approach making use of HFCS portfolio structures to quantify the impact of the missing wealthy households on instrument-specific gaps between micro and macro data. We analyse data for Austria and Germany, and find that adjusting for the missing wealthy pushes up inequality even further, increases instrument-specific aggregates, has large effects on equity, but explains less than ten percentage points of the micro-macro gap for most other instruments. Additionally, we document that some countries’ lack of an oversampling strategy for wealthy households limits the cross-country comparability of wealth inequality statistics.

No. 2162
20 June 2018
Foreign-law bonds: can they reduce sovereign borrowing costs?

Abstract

JEL Classification

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

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

K22 : Law and Economics→Regulation and Business Law→Business and Securities Law

Abstract

Governments often issue bonds in foreign jurisdictions, which can provide additional legal protection vis-à-vis domestic bonds. This paper studies the effect of this jurisdiction choice on a bond prices. We test whether foreign-law bonds trade at a premium compared to domestic-law bonds. We use the euro area 2006-2013 as a unique testing ground, controlling for currency risk, liquidity risk, and term structure. Foreign-law bonds indeed carry significantly lower yields in distress periods, and this effect rises as the risk of a sovereign default increases. These results indicate that, in times of crisis, governments can borrow at lower rates under foreign law.

No. 2161
20 June 2018
Are asset price data informative about news shocks? A DSGE perspective

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

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

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

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

Abstract

Standard economic intuition suggests that asset prices are more sensitive to news than other economic aggregates. This has led many researchers to conclude that asset price data would be very useful for the estimation of business cycle models containing news shocks. This paper shows how to formally evaluate the information content of observed variables with respect to unobserved shocks in structural macroeconomic models. The proposed methodology is applied to two different real business cycle models with news shocks. The contribution of asset prices is found to be relatively small. The methodology is general and can be used to measure the informational importance of observables with respect to latent variables in DSGE models. Thus, it provides a framework for systematic treatment of such issues, which are usually discussed in an informal manner in the literature.

No. 2160
19 June 2018
Cross-country linkages and spill-overs in early warning models for financial crises

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises

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

F37 : International Economics→International Finance→International Finance Forecasting and Simulation: Models and Applications

F65 : International Economics→Economic Impacts of Globalization→Finance

Abstract

This paper uses data on bilateral foreign exposures of domestic banking systems in order to construct early warning models for financial crises that take into account cross-country spill-overs of vulnerabilities. The empirical results show that incorporating cross-country financial linkages can improve the signalling performance of early warning models. The relative usefulness increases from 65% to 87% and the AUROC from 0.89 to 0.97 when weighted foreign variables are added to domestic variables in a multivariate logit early warning model. The findings of the paper also suggest that global variables still play a role in predicting financial crises, even when foreign variables are controlled for, which could suggest that both cross-country spill-overs and contagion are important factors for driving financial crises. A parsimonious model with nine variables that combines domestic, foreign and global variables yields an out-of-sample relative usefulness of 0.82 with Type I and Type II errors of 0.11 and 0.07.

No. 2159
19 June 2018
Nominal wage rigidity in the EU countries before and after the Great Recession: evidence from the WDN surveys

Abstract

JEL Classification

B41 : History of Economic Thought, Methodology, and Heterodox Approaches→Economic Methodology→Economic Methodology

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

Abstract

This paper studies the recent trends in nominal wage rigidity in a large group of EU countries, using survey data. We analyse two forms of nominal wage rigidity: downward nominal wage rigidity (DNWR) and the lagged response of wages to shocks. The frequency of wage changes, which is an indicator of lagged wage setting, slowed down in the aftermath of the Great Recession. We assess the possible reasons for this and show that it was at least partially caused by a combination of a decline in average wage growth and persistent DNWR. In countries where wage growth slowed down more after the Great Recession, the frequency of wage changes declined more steeply as well. Our data allows evaluating the prevalence of DNWR in diverse economic circumstances. Like earlier research on this topic, we find that DNWR tends to be strongly prevalent, even in periods of slow economic growth and low wage inflation. DNWR declines during severe recessions but even then wage setting does not become completely flexible as the proportion of observed wage cuts is still below the level that would correspond to a flexible regime.

No. 2158
15 June 2018
Non-base wage components as a source of wage adaptability to shocks: evidence from European firms, 2010–2013

Abstract

JEL Classification

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

J32 : Labor and Demographic Economics→Wages, Compensation, and Labor Costs→Nonwage Labor Costs and Benefits, Retirement Plans, Private Pensions

C81 : Mathematical and Quantitative Methods→Data Collection and Data Estimation Methodology, Computer Programs→Methodology for Collecting, Estimating, and Organizing Microeconomic Data, Data Access

P5 : Economic Systems→Comparative Economic Systems

Abstract

This paper provides evidence on the role of non-base wage components as a channel for firms to adjust labour costs in the event of adverse shocks. It uses data from a firm-level survey for 25 European countries that covers the period 2010–2013. We find that firms subject to nominal wage rigidities, which prevent them from adjusting base wages, are more likely to cut non-base wage components in order to adjust labour costs when needed. Firms thus use non-base wage components as a buffer to overcome base wage rigidity. We further show that while nonbase wage components exhibit some degree of downward rigidity, they do so to a lesser extent than base wages.

No. 2157
15 June 2018
Wealth effects in the euro area

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

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

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

Abstract

How sizable is the wealth effect on consumption in euro area countries? To address this question, we use newly available harmonized euro area wealth data and the methodology in Carroll et al. (2011b). We find that the marginal propensity to consume out of total wealth averaged across the largest euro area economies is around 3 cents per euro, with a marginal propensity to consume out of financial wealth significantly larger than of housing wealth. Country-group estimates document no significant differences between the largest economies and the rest of the sample. In contrast, remarkable differences emerge between periphery and core countries.

No. 2156
5 June 2018
Designing QE in a fiscally sound monetary union

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

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 develops a tractable model of a monetary union with a sound fiscal governance structure and shows how in such environment the design of monetary policy above and at the lower bound constraint on short-term interest rates can be linked to well-known findings from the literature dealing with single closed economies. The model adds a portfolio balance channel to a New Keynesian two-country model of a monetary union. If the monetary union is symmetric and the portfolio balance channel is not active, the model becomes isomorphic to the canonical New Keynesian three-equation economy in which central bank purchases of long-term debt (QE) at the lower bound are ineffective. If the portfolio balance channel is active, QE becomes effective and we prove that for sufficiently small shocks there exists an interest rate rule augmented by QE at the lower bound which replicates the equilibrium allocation and the welfare level of a hypothetically unconstrained economy. Shocks large enough to push the whole yield curve to the lower bound require, in addition, forward guidance. We generalise these results to an asymmetric monetary union and illustrate them through simulations, distinguishing between asymmetric shocks and asymmetric structures. In general, asymmetries give rise to current account imbalances which are, depending on the degree of financial integration, funded by private capital imports or through the central bank balance sheet channel. Moreover, our findings support that at the lower bound, as long as asymmetries between countries result from shocks, outcomes under an unconstrained policy rule can be replicated via a symmetric QE design. By contrast, asymmetric structures of the countries which matter for the transmission of monetary policy can translate into an asymmetric QE design.

No. 2155
5 June 2018
Coordinating monetary and financial regulatory policies

Abstract

JEL Classification

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

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

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

G01 : Financial Economics→General→Financial Crises

Abstract

How to conduct macro-prudential regulation? How to coordinate monetary policy and macro-prudential policy? To address these questions, I develop a continuous-time New Keynesian economy in which a financial intermediary sector is subject to a leverage constraint. Coordination between monetary and macro-prudential policies helps to reduce the risk of entering into a financial crisis and speeds up exit from the crisis. The downside of coordination is variability in inflation and in the employment gap.

No. 2154
30 May 2018
Learning about fiscal multipliers during the European sovereign debt crisis: evidence from a quasi-natural experiment

Abstract

JEL Classification

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

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

H20 : Public Economics→Taxation, Subsidies, and Revenue→General

H5 : Public Economics→National Government Expenditures and Related Policies

Abstract

Identifying fiscal multipliers is usually constrained by the absence of a counterfactual scenario. Our new data set allows overcoming this problem by making use of the fact that recommendations under the EU’s excessive deficit procedure (EDP) provide both a baseline no-policy-change scenario and a fiscal-adjustment EDP scenario that entails a forecast of the macroeconomic impact of fiscal consolidation over the EDP horizon. For a sample of 24 EU countries to which 48 EDP recommendations were applied between 2009 and 2015, we derive country-specific fiscal multipliers as actually applied by forecasters during the crisis. Our results confirm Blanchard and Leigh’s (2013, 2014) presumption that forecasters learned during the crisis. According to our findings, fiscal multipliers as applied by the European Commission increased over time – from about 1/4 in the early years of the crisis to about 2/3 in the later years. However, different from Blanchard and Leigh (2013, 2014), we do not find evidence for the hypothesis that ex-post fiscal multipliers have been substantially above 1 during the crisis.

No. 2153
25 May 2018
What are the main obstacles to hiring after recessions in Europe?

Abstract

JEL Classification

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

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

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

Abstract

This paper assesses the relative importance of perceived obstacles to hiring workers on a permanent basis faced by EU firms and studies how they depend on firm’s characteristics. Findings suggest that the main obstacles to hiring in Europe are high uncertainty, shortage of skilled labour, high payroll taxes, high wages and the risks associated with changes to labour laws. While negative (firm-level) demand and finance shocks negatively affect firms’ perceptions of obstacles to hiring, labour market structures and firms’/employees’ characteristics are also found significant. In particular, our analysis shows that firms employing a higher percentage of skilled, permanent and experienced workers report fewer hiring obstacles. In contrast, firms under collective wage bargaining arrangements seem to report these obstacles more often. However, there are also some specific obstacles to hiring where this is not the case, which suggests that firm-level characteristics should also be taken into account when designing labour market policies. Finally, our analysis provides further tentative evidence on the impacts of labour market reforms, which seem to have a potential to address impediments towards employment creation in the EU.

No. 2152
25 May 2018
Sticky expectations and consumption dynamics

Abstract

JEL Classification

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

D84 : Microeconomics→Information, Knowledge, and Uncertainty→Expectations, Speculations

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

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

Abstract

Macroeconomic models often invoke consumption "habits" to explain the substantial persistence of macroeconomic consumption growth. to explain the substantial But a large literature has found no evidence of habits in the micro-economic datasets that measure the behavior of individual households. We show that the apparent conflict can be explained by a model in which consumers have accurate knowledge of their personal circumstances but `sticky expectations' about the macro-economy. In our model, the persistence of aggregate consumption growth reflects consumers' imperfect attention to aggregate shocks. Our proposed degree of (macro) inattention has negligible utility costs, because aggregate shocks constitute only a tiny proportion of the uncertainty that consumers face.

No. 2151
22 May 2018
Exchange rate forecasting on a napkin

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

F31 : International Economics→International Finance→Foreign Exchange

F37 : International Economics→International Finance→International Finance Forecasting and Simulation: Models and Applications

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

Abstract

This paper shows that there are two regularities in foreign exchange markets in advanced countries with flexible regimes. First, real exchange rates are mean-reverting, as implied by the Purchasing Power Parity model. Second, the adjustment takes place via nominal exchange rates. These features of the data can be exploited, even on the back of a napkin, to generate nominal exchange rate forecasts that outperform the random walk. The secret is to avoid estimating the pace of mean reversion and assume that relative prices are unchanged. Direct forecasting or panel data techniques are better than the random walk but fail to beat this simple calibrated model.

No. 2150
22 May 2018
Asset pricing and the propagation of financial shocks

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

G10 : Financial Economics→General Financial Markets→General

Abstract

This study augments the neoclassical growth model with a mechanism that creates a novel transmission channel through which financial shocks propagate to the real economy. By affecting agents’ ability to finance consumption expenditures, financial frictions create a demand for safe assets that exposes the economy to asset quality shocks. My main finding is that this mechanism provides a potential explanation for the co-movement observed during the 2007-2009 financial crisis in the eurozone. My results also suggest that these shocks are a plausible source of aggregate risk that could explain business cycle fluctuations as well as standard asset pricing puzzles. Finally, introducing this transmission mechanism into the neoclassical growth model increases the welfare cost of business cycle fluctuations by several orders of magnitude.

No. 2149
2 May 2018
From carry trades to curvy trades

Abstract

JEL Classification

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

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

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

Abstract

Traditional carry trade strategies are based on differences in short-term interest rates, neglecting any other information embedded in yield curves. We derive return distributions of carry trade portfolios among G10 currencies, where the signals to buy and sell currencies are based on summary measures of the yield curve, the Nelson-Siegel factors. We find that a strategy based on the relative curvature factor, the curvy trade, yields higher Sharpe ratios and a smaller return skewness than traditional carry trade strategies. Curvy trades build less upon the typical carry currencies, like the Japanese yen and the Swiss franc, and are hence less susceptible to crash risk. In line with that, standard pricing factors of traditional carry trade returns, such as exchange rate volatility, fail to explain curvy trade returns in a linear asset pricing framework. Our findings are in line with recent interpretations of the curvature factor. A relatively high curvature signals a relatively higher path of future short-term rates over the medium-term putting upward pressure on the currency.

No. 2148
2 May 2018
Private and public risk sharing in the euro area

Abstract

JEL Classification

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

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

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

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

Abstract

This paper investigates the contribution of private and public channels for consumption risk sharing in the EMU over the period 1999-2015. In particular, we explore the role of financial integration versus international financial assistance for private consumption smoothing in this set of countries. In addition, we present a time-varying test which allows estimating how risk sharing has evolved since the start of the EMU, and in particular during the recent crisis. Our results suggest that, whereas in the early years of the EMU only about 40% of country-specific output shocks were smoothed, in the aftermath of the euro zone’s sovereign debt crisis about 65% of these shocks were absorbed, therefore reducing consumption growth differentials across countries. This progressive improvement of the shock-absorption capacity is due to a higher financial integration, but also to the activation of the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM) channelling official loans to distressed euro zone economies. We also show that cross-border holdings of equities and debt seem to be more effective than cross-border bank loans in isolating households from country-specific shocks, therefore contributing to consumption smoothing.

No. 2147
30 April 2018
The evolving impact of global, region-specific and country-specific uncertainty

Abstract

JEL Classification

C15 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Statistical Simulation Methods: General

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

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

Abstract

We build a dynamic factor model with time-varying parameters and stochastic volatility and use it to decompose the variance of a large set of financial and macroeconomic variables for 22 OECD countries spanning from 1960 onwards into contributions from country-specific uncertainty, region-specific uncertainty and uncertainty common to all countries. We find that common global uncertainty plays a primary role in explaining the volatility of inflation, interest rates and stock prices, although to a varying extent over time. Region-specific uncertainty drives most of the exchange rate volatility for all Euro Area countries and for countries in North-America and Oceania. All uncertainty estimates (global, regional, country-specific and idiosyncratic) play a non-negligible role for real economic activity, credit and money for most countries. We also find that all uncertainty measures display significant recurrent fluctuations, that the recent peaks in uncertainty found for most estimates around 2008/2009 are comparable to those seen in the mid-1970s and early 1980s, and that all uncertainty measures appear to be strongly countercyclical and positively correlated with inflation.

No. 2146
27 April 2018
Politics, banks, and sub-sovereign debt: unholy trinity or divine coincidence?

Abstract

JEL Classification

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

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

P16 : Economic Systems→Capitalist Systems→Political Economy

Abstract

We exploit election-driven turnover in State and local governments in Germany to study how banks adjust their securities portfolios in response to the loss of political connections. We find that local savings banks, which are owned by their host county and supervised by local politicians, increase significantly their holdings of home-State sovereign bonds when the local government and the State government are dominated by different political parties. Banks’ holdings of other securities, like federal bonds, bonds issued by other States, or stocks, are not affected by election outcomes. We argue that banks use sub-sovereign bond purchases to gain access to politically distant government authorities.

No. 2145
18 April 2018
Who benefits from the corporate QE? A regression discontinuity design approach

Abstract

JEL Classification

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

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

G30 : Financial Economics→Corporate Finance and Governance→General

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

Abstract

On March 10, 2016, the European Central Bank (ECB) announced the Corporate Sector Purchase Programme (CSPP) – commonly known as corporate quantitative easing (QE) – to improve the financing conditions of the Eurozone’s real economy and strengthen the pass-through of unconventional monetary interventions. Using a regression discontinuity design framework that exploits the rating wedge between the ECB and market participants, we show that: (i) bond yield spreads decline by around 15 basis points at the announcement of the programme, (ii) the impact is mostly noticeable in the sample of CSPP-eligible bonds that are perceived as high yield from the viewpoint of market participants and, (iii) the CSPP seems to have stimulated new issuance of corporate bonds. Overall, our results are consistent with the explanation that highlights the portfolio rebalancing mechanism and the liquidity channel.

No. 2144
18 April 2018
Countercyclical capital regulation in a small open economy DSGE model

Abstract

JEL Classification

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

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

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

Abstract

We examine, conditional on structural shocks, the macroeconomic performance of different countercyclical capital buffer (CCyB) rules in small open economy estimated medium scale DSGE. We find that rules based on the credit gap create a trade-off between the stabilization of fluctuations originating in the housing market and fluctuations caused by foreign demand shocks. The trade-off disappears if the regulator targets house prices instead. As a result, the optimal simple CCyB rule depends only on the house price but not the credit gap. Moreover, the optimal simple rule leads to significant welfare gains compared to the no CCyB case.

No. 2143
11 April 2018
The post-crisis TFP growth slowdown in CEE countries: exploring the role of Global Value Chains

Abstract

JEL Classification

O33 : Economic Development, Technological Change, and Growth→Technological Change, Research and Development, Intellectual Property Rights→Technological Change: Choices and Consequences, Diffusion Processes

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

O57 : Economic Development, Technological Change, and Growth→Economywide Country Studies→Comparative Studies of Countries

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

Abstract

Using micro-aggregated firm information for nine Central and Eastern European (CEE) countries and data from input-output tables, we examine the role of Global Value Chains (GVCs) for technology diffusion across EU countries. Our empirical results provide support for a two-stage diffusion process of technology across countries. In the first stage, the most productive firms in the host economy benefit from their direct exposure to new technology created in parent firms as a result of their GVC participation. In the second stage, technology spills over to the rest of firms in the host economy via domestic production networks. In addition, we show that the import of intermediate inputs –i.e. backward linkages- is the main channel of technology diffusion within GVCs. We use these results to explain the pronounced post-crisis drop in Total Factor Productivity (TFP) growth in CEE countries. We show that due to their deep integration in GVCs, CEE countries have been exposed to two recent developments highly correlated with their TFP performance: (i) a slowdown in TFP growth of parent firms located in non-CEE EU countries; and (ii) a global slowdown in the growth rate of GVC participation, which is evident also for CEE countries from 2011 onwards. Moreover, we find that the capacity of host firms in CEE countries to absorb and understand new knowledge has decreased since the crisis. We argue that this is related to the drop in R&D investment in the CEE region during the post-crisis period.

No. 2142
10 April 2018
On the optimal labor income share

Abstract

JEL Classification

O33 : Economic Development, Technological Change, and Growth→Technological Change, Research and Development, Intellectual Property Rights→Technological Change: Choices and Consequences, Diffusion Processes

O41 : Economic Development, Technological Change, and Growth→Economic Growth and Aggregate Productivity→One, Two, and Multisector Growth Models

Abstract

Labor’s share of income has attracted interest in recent years reflecting its apparent decline. These falls, witnessed across many countries, are usually deemed undesirable. Any such assertion, however, begs the question of what is the socially optimal labor share. We address this question using a micro-founded endogenous growth model calibrated on US data. We find that in our central calibration the socially optimal labor share is 17% (11 pp) above the decentralized equilibrium, calibrated to match the average observed in history. We also study the dependence of both long-run growth equilibria on model parameters and relate our results to Piketty’s “laws of Capitalism”. Finally, we demonstrate that cyclical movements in factor income shares are socially optimal and that the decentralized equilibrium typically does not generate excess volatility.

No. 2141
10 April 2018
Consumption volatility risk and the inversion of the yield curve

Abstract

JEL Classification

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

Abstract

We propose a consumption-based model that allows for an inverted term structure of real and nominal risk-free rates. In our framework the agent is subject to time-varying macroeconomic risk and interest rates at all maturities depend on her risk perception which shape saving propensities over time. In bad times, when risk is perceived to be higher in the short- than the long-term, the agent would prefer to hedge against low realizations of consumption in the near future by investing in long-term securities. This determines, in equilibrium, the inversion of the yield curve. Pricing time-varying consumption volatility risk is essential for obtaining the inversion of the real curve and allows to price the average level and slope of the nominal one.

No. 2140
6 April 2018
Euro area real-time density forecasting with financial or labor market frictions

Abstract

JEL Classification

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

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

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

We compare real-time density forecasts for the euro area using three DSGE models. The benchmark is the Smets-Wouters model and its forecasts of real GDP growth and inflation are compared with those from two extensions. The first adds financial frictions and expands the observables to include a measure of the external finance premium. The second allows for the extensive labor-market margin and adds the unemployment rate to the observables. The main question we address is if these extensions improve the density forecasts of real GDP and inflation and their joint forecasts up to an eight-quarter horizon. We find that adding financial frictions leads to a deterioration in the forecasts, with the exception of longer-term inflation forecasts and the period around the Great Recession. The labor market extension improves the medium to longer-term real GDP growth and shorter to medium-term inflation forecasts weakly compared with the benchmark model.

No. 2139
6 April 2018
Monetary policy and cross-border interbank market fragmentation: lessons from the crisis

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

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

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

Abstract

We present a two-country model with an enhanced banking sector featuring risky lending and cross-border interbank market frictions. We find that (i) the strength of the financial accelerator, when applied to banks operating under uncertainty in an interbank market, will critically depend on the economic and financial structure of the economy; (ii) adverse shocks to the real economy can be the source of banking crisis, causing an increase in interbank funding costs, aggravating the initial shock; and (iii) central bank asset purchases and long-term refinancing operations can be effective substitutes for, or supplements to, conventional monetary policy.

No. 2138
28 March 2018
Detrending and financial cycle facts across G7 countries: mind a spurious medium term!

Abstract

JEL Classification

C10 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→General

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

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

I show that the detrending of financial variables with the Hodrick and Prescott (1981, 1997) (HP) and band-pass filters leads to spurious cycles. I find that distortions become especially severe when considering medium-term cycles, i.e., cycles that exceed the duration of regular business cycles. In particular, these medium-term filters amplify the variances of cycles of duration around 20 to 30 years up to a factor of 204, completely cancelling out shorter-term fluctuations. This is important because it is common practice, and recommended under Basel III, to extract medium-term cycles using such filters; e.g., the HP filter with a smoothing parameter of 400,000. In addition, I find that financial cycle facts, i.e., differing amplitude, duration, and synchronisation of cycles in financial variables relative to cycles in GDP, are robust. For HP and band-pass filters, differences to GDP become marginal due to spurious cycles.

No. 2137
27 March 2018
A minimal moral hazard central stabilisation capacity for the EMU based on world trade

Abstract

JEL Classification

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

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

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

Recent debate has focused on the introduction of a central stabilisation capacity as a completing element of the Economic and Monetary Union. Its main objective would be to contribute cushioning country-specific economic shocks, especially when national fiscal stabilisers are run down. There are two main potential objections to such schemes proposed so far: first, they may lead to moral hazard, i.e. weaken the incentives for sound fiscal policies and structural reforms. Second, they may generate permanent transfers among countries. Here we present a scheme that is relatively free from moral hazard, because the transfers are based on changes in world trade in the various sectors. These changes can be considered as largely exogenous, hence independent from an individual government’s policy; therefore, the scheme is better protected against manipulation. Our scheme works as follows: if a sector is hit by a bad shock at the world market level, then a country with an economic structure that is skewed towards this sector receives a (one-time) transfer from the other countries. The scheme is designed such that the transfers add up to zero each period, hence obviating the need for a borrowing capacity. We show that the transfers generated by our scheme tend to be countercyclical and larger when economies are less diversified. In addition, since transfers are based on temporary changes in world trade, the danger of permanent transfers from one set of countries to the other countries is effectively ruled out. Finally, we show that transfers are quite robust to revisions in the underlying export data.

No. 2136
1 March 2018
Dealing with endogeneity in threshold models using copulas: an illustration to the foreign trade multiplier

Abstract

JEL Classification

C12 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Hypothesis Testing: General

C13 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Estimation: General

C21 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Cross-Sectional Models, Spatial Models, Treatment Effect Models, Quantile Regressions

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

Abstract

We suggest a new method dealing with the problem of endogeneity of the threshold variable in single regression threshold models and seemingly unrelated systems of them based on copula theory. This theory enables us to relax the assumption that the threshold variable is normally distributed and to capture the dependence between the error term and the threshold variable in each regime of the model independently of the marginal distribution of the threshold variable. This distribution can be estimated non-parametrically conditionally on the value of threshold parameter. To estimate the slope and threshold parameters of the model adjusted for the endogeneity of the threshold variable, we suggest a two-step concentrated least squares estimation method where the threshold parameter is estimated based on a search procedure, in the first step. A Monte Carlo study indicates that the suggested method deals with the endogeneity problem of the threshold variable satisfactorily. As an empirical illustration, we estimate a threshold model of the foreign-trade multiplier conditional on the real exchange rate volatility regime. We suggest a bootstrap procedure to examine if there are significant differences in the foreign-trade multiplier effects across the two regimes of the model, under potential endogeneity of the threshold variable.

No. 2135
28 February 2018
Sovereign defaults in court

Abstract

JEL Classification

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

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

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

K22 : Law and Economics→Regulation and Business Law→Business and Securities Law

Abstract

For centuries, defaulting governments were immune from legal action by foreign creditors. This paper shows that this is no longer the case. Building a dataset covering four decades, we find that creditor lawsuits have become an increasingly common feature of sovereign debt markets. The legal developments have strengthened the hands of creditors and raised the cost of default for debtors. We show that legal disputes in the US and the UK disrupt government access to international capital markets, as foreign courts can impose a financial embargo on sovereigns. The findings are consistent with theoretical models with creditor sanctions and suggest that sovereign debt is becoming more enforceable. We discuss how the threat of litigation affects debt management, government willingness to pay, and the resolution of debt crises.

No. 2134
28 February 2018
Spillovers in space and time: where spatial econometrics and Global VAR models meet

Abstract

JEL Classification

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

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

Abstract

We bring together the spatial and global vector autoregressive (GVAR) classes of econometric models by providing a detailed methodological review of where they meet in terms of structure, interpretation, and estimation methods. We discuss the structure of cross-section connectivity (weight) matrices used by these models and its implications for estimation. Primarily motivated by the continuously expanding literature on spillovers, we define a broad and measurable concept of spillovers. We formalize it analytically through the indirect effects used in the spatial literature and impulse responses used in the GVAR literature. Finally, we propose a practical step-by-step approach for applied researchers who need to account for the existence and strength of cross-sectional dependence in the data. This approach aims to support the selection of the appropriate modeling and estimation method and of choices that represent empirical spillovers in a clear and interpretable form.

No. 2133
27 February 2018
Deconstructing monetary policy surprises: the role of information shocks

Abstract

JEL Classification

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

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 bank announcements simultaneously convey information about monetary policy and the central bank’s assessment of the economic outlook. This paper disentangles these two components and studies their effect on the economy using a structural vector autoregression. It relies on the information inherent in high-frequency comovement of interest rates and stock prices around policy announcements: a surprise policy tightening raises interest rates and reduces stock prices, while the complementary positive central bank information shock raises both. These two shocks have intuitive and very different effects on the economy. Ignoring the central bank information shocks biases the inference on monetary policy non-neutrality. We make this point formally and offer an interpretation of the central bank information shock using a New Keynesian macroeconomic model with financial frictions.

No. 2132
27 February 2018
Priors for the long run

Abstract

JEL Classification

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

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

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

Abstract

We propose a class of prior distributions that discipline the long-run behavior of Vector Autoregressions (VARs). These priors can be naturally elicited using economic theory, which provides guidance on the joint dynamics of macroeconomic time series in the long run. Our priors for the long run are conjugate, and can thus be easily implemented using dummy observations and combined with other popular priors. In VARs with standard macroeconomic variables, a prior based on the long-run predictions of a wide class of theoretical models yields substantial improvements in the forecasting performance.

No. 2131
26 February 2018
Predicting risk premia in short-term interest rates and exchange rates

Abstract

JEL Classification

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

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

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

Abstract

We assess the ability of yield curve factors to predict risk premia in short-term interest rates and exchange rates across a large sample of major advanced economies. We find that the same tick-shaped linear combination of (relative) bond yields predicts risk premia in both short-term interest rates and exchange rates at returnforecasting horizons of up to six months for all (but one) countries and currencies in our sample. Our single forecasting factor loads positively on the short and long end of the curve and negatively on the medium-term and is therefore inversely related to Nelson-Siegel’s curvature factor. In line with recent interpretations of the yield curve factors, our findings suggest that the hump of the yield curve bears important information about future short-term interest rates. A relatively high curvature predicts a surprise rise in short-term interest rates beyond expectations and, coincidentally, an appreciation of the home currency in line with uncovered interest rate parity.

No. 2130
26 February 2018
Cross-border banking in the EU since the crisis: what is driving the great retrenchment?

Abstract

JEL Classification

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

F30 : International Economics→International Finance→General

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

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

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

Abstract

This paper examines the drivers of the retrenchment in cross-border banking in the European Union (EU) since the global financial crisis, which stands out in international comparison as banks located in the euro area and in the rest of the EU reduced their cross-border claims by around 25%. Particularly striking is the sharp and sustained reduction in intra-EU claims, especially in the form of deleveraging from cross-border interbank loans. Examining a wide range of possible determinants, we identify high non-performing loans as an important impediment to cross-border lending after the crisis, highlighting the spillovers from national banking sector conditions across the EU. We also find evidence that prudential policies can entail spillovers via cross-border banking in the EU, albeit with heterogeneity across instruments in terms of direction, magnitude and significance. Our results do not point to a major role of newly introduced bank levies in explaining cross-border banking developments.

No. 2129
5 February 2018
Tight money - tight credit: coordination failure in the conduct of monetary and 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

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

Abstract

Quantitative analysis of a New Keynesian model with the Bernanke-Gertler accelerator and risk shocks shows that violations of Tinbergen’s Rule and strategic interaction between policymaking authorities undermine significantly the effectiveness of monetary and financial policies. Separate monetary and financial policy rules, with the latter subsidizing lenders to encourage lending when credit spreads rise, produce higher welfare and smoother business cycles than a monetary rule augmented with credit spreads. The latter yields a tight money-tight credit regime in which the interest rate responds too much to inflation and not enough to adverse credit conditions. Reaction curves for the choice of policy-rule elasticity that minimizes each authority’s loss function given the other authority’s elasticity are nonlinear, reflecting shifts from strategic substitutes to complements in setting policy-rule parameters. The Nash equilibrium is significantly inferior to the Cooperative equilibrium, both are inferior to a first-best outcome that maximizes welfare, and both produce tight money-tight credit regimes.

No. 2128
5 February 2018
Time-consistent monetary policy, terms of trade manipulation and welfare in open economies

Abstract

JEL Classification

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

Abstract

A key insight from the open economy literature is that domestic price stability is in general not optimal for countries that exert some market power over their terms of trade. Under commitment, a national benevolent monetary policymaker improves upon the allocation associated with stable domestic prices by manipulating the terms of trade to her own country’s advantage. In this paper, I study optimal monetary policy in a sticky-price small open economy model when the policymaker lacks a commitment device. Without commitment, the benevolent policymaker’s attempt to improve national welfare by manipulating the terms of trade can be self-defeating. By steering international relative prices the discretionary policymaker induces fluctuations in domestic prices, the costs of which she is unable to fully internalize in her decision-making. Society may thus be better off if it appoints an inward-looking policymaker who aims for domestic price stability and resists the temptation to exploit the country’s monopoly power in trade. Accounting for the effective lower bound on nominal interest rates further strengthens the case for the inward-looking policy objective.

No. 2127
1 February 2018
Labour tax reforms, cross-country coordination and the monetary policy stance in the euro area: a structural model-based approach

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

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

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

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

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

Abstract

We evaluate the effects of permanently reducing labour tax rates in the euro area (EA) by simulating a large-scale open economy dynamic general equilibrium model. The model features the EA as a monetary union, split in two regions (Home and the rest of the EA - REA), the US, and the rest of the world, region-specific labour markets with search and matching frictions, and public employment. Our results are as follows. First, a permanent reduction in labour tax rates in the Home region would have stimulating effects on domestic economic activity and employment. Second, reducing labour tax rates simultaneously in both Home and REA would have additional expansionary effects on the Home region. Third, in the short run the expansionary effects on the EA economy of a EA-wide tax reduction are enhanced if the EA monetary policy is accommodative.

No. 2126
1 February 2018
Credit constraints, firm investment and growth: evidence from survey data

Abstract

JEL Classification

G30 : Financial Economics→Corporate Finance and Governance→General

G31 : Financial Economics→Corporate Finance and Governance→Capital Budgeting, Fixed Investment and Inventory Studies, Capacity

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

Abstract

We assess the impact of credit constraints on investment, inventories and other working capital and firm growth with a large panel of small and medium-sized enterprises from 12 European countries for the period 2014-2016. The data come from the Survey on the access to finance of enterprises (SAFE), a survey that is especially designed to analyse the problems in the access to external finance of European SMEs. The key identification challenge is a potential reverse-causality bias, as firms with poor investment and growth opportunities may have a higher probability of being credit constrained. We implement several strategies to overcome this obstacle: proxies for investment opportunities, lagged regressors, random effects and instrumental variables. Our findings suggest that credit constraints, both in bank financing and other financing (e.g. trade credit), have strong negative effects on investment in fixed assets, while the impact on firm growth and working capital is less robust.

No. 2125
31 January 2018
Portfolio rebalancing and the transmission of large-scale asset programmes: evidence from the euro area

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

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

Abstract

Large-scale asset programmes aim to impact the real economy through the financial system. The ECB has focused much of its policies on safe assets. An intended channel of transmission of this type of programme is the “portfolio rebalancing channel”, whereby investors are influenced to shift their investments away from such safe assets towards assets with higher expected returns, including lending to households and firms. We examine the portfolio rebalancing channel around the ECB’s asset purchase program (APP). We exploit cross-sectional heterogeneity in the impact of APP on the valuation of the financial portfolio held by different sectors of the European economy. Overall, our results provide evidence of an active portfolio rebalancing channel. In more vulnerable countries, where macroeconomic unbalances and relatively high risk premia remain, APP was mostly reflected into a rebalancing towards riskier securities. In less vulnerable countries, where constraints on loan demand and supply are less significant, the rebalancing was observed mostly in terms of bank loans. Examining large European banks, we confirm similar geographical differences.

No. 2124
31 January 2018
Credit shocks and the European labour market

Abstract

JEL Classification

D53 : Microeconomics→General Equilibrium and Disequilibrium→Financial Markets

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

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

G31 : Financial Economics→Corporate Finance and Governance→Capital Budgeting, Fixed Investment and Inventory Studies, Capacity

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

Abstract

More than five years after the start of the Sovereign debt crisis in Europe, its impact on labour market outcomes is not clear. This paper aims to fill this gap. We use qualitative firm-level data for 24 European countries, collected within the Wage Dynamics Network (WDN) of the ESCB. We first derive a set of indices measuring difficulties in accessing the credit market for the period 2010-13. Second, we provide a description of the relationship between credit difficulties and changes in labour input both along the extensive and the intensive margins as well as on wages. We find strong and significant correlation between credit difficulties and adjustments along both the extensive and the intensive margin. In the presence of credit market difficulties, firms cut wages by reducing the variable part of wages. This evidence suggests that credit shocks can affect not only the real economy, but also nominal variables.

No. 2123
15 January 2018
Macroprudential regulation in the European Union in 1995-2014: introducing a new data set on policy actions of a macroprudential natureMacroPrudential Policies Evaluation Database

Abstract

JEL Classification

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

E60 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→General

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

Abstract

This paper introduces a new comprehensive data set on policies of a macroprudential nature in the banking sectors of the 28 member states of the European Union (EU) between 1995 and 2014. The Macroprudential Policies Evaluation Database (MaPPED) offers a detailed overview of the “life-cycle” of policy instruments which are either genuinely macroprudential or are essentially microprudential but likely to have a significant impact on the whole banking system. It tracks events of the introduction, recalibration and termination of eleven categories and 53 subcategories of instruments. MaPPED has been based on a carefully designed questionnaire, which has been completed in cooperation with experts from national central banks and supervisory authorities of all EU member states. This paper describes the design and structure of the new data set and presents the first descriptive analysis of the use of policy measures with a macroprudential nature in the EU over the last two decades. The results indicate that there has been a remarkable variation in the use of policies of a macroprudential nature both across EU countries and over time. Moreover, the analysis provides some tentative evidence of an impact of capital buffers, lending restrictions and caps on maturity mismatches on credit to the non-financial private sector in the EU as well as of the relative ineffectiveness of sectoral risk weights in controlling credit growth.

No. 2122
10 January 2018
How do firms adjust to rises in the minimum wage? Survey evidence from Central and Eastern Europe

Abstract

JEL Classification

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

E23 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Production

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

Abstract

We study the transmission channels for rises in the minimum wage using a unique firm-level dataset from eight Central and Eastern European countries. Representative samples of firms in each country were asked to evaluate the relevance of a wide range of adjustment channels following specific instances of rises in the minimum wage during the recent post-crisis period. The paper adds to the rest of literature by presenting the reactions of firms as a combination of strategies, and evaluates the relative importance of those strategies. Our findings suggest that the most popular adjustment channels are cuts in non-labour costs, rises in product prices, and improvements in productivity. Cuts in employment are less popular and occur mostly through reduced hiring rather than direct layoffs. Our study also provides evidence of potential spillover effects that rises in the minimum wage can have on firms without minimum wage workers.

No. 2121
10 January 2018
Agent-based model of system-wide implications of funding risk

Abstract

JEL Classification

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

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

C61 : Mathematical and Quantitative Methods→Mathematical Methods, Programming Models, Mathematical and Simulation Modeling→Optimization Techniques, Programming Models, Dynamic Analysis

Abstract

Liquidity has its systemic aspect that is frequently neglected in research and risk management applications. We build a model that focuses on systemic aspects of liquidity and its links with solvency conditions accounting for pertinent interactions between market participants in an agent-based modelling fashion. The model is confronted with data from the 2014 EU stress test covering all the major banking groups in the EU. The potential amplification role of asset managers is taken into account in a stylised fashion. In particular, we investigate the importance of the channels through which the funding shock to financial institutions can spread across the financial system.

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.