Working papers

In-depth studies for experts

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

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No. 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.