New deliverables published:

D1.4: Endogenous Asymmetric Shocks in the Eurozone: the Role of Animal Spirits (CEPS)

Abstract: Business cycles among Eurozone countries are highly correlated. We develop a two-country behavioral macroeconomic model in a monetary union setting where the two countries are linked with each other by international trade. The net export of country 1 depends on the output gap of country 2 and on real exchange rate movements. The synchronization of the business cycle is produced endogenously. The main channel of synchronization occurs through a propagation of “animal spirits”, i.e. waves of optimism and pessimism that become correlated internationally. We find that this propagation occurs with relatively low levels of trade integration. We analyze the role of the common central bank in this propagation mechanism. We explore the transmission of demand and supply shocks and we study how the central bank affects this transmission. We verify the main predictions of the model empirically.

D2.5: Analysing the Relevance and Predictive Power of the MIP Scoreboard’s Indicators (IERSAS)

Abstract: This research aims to evaluate crisis prediction ability of the Macroeconomic Imbalance Procedure Scoreboard’s headline and auxiliary indicators. We test the indicators separately by employing signals approach and loss and usefulness function of the policymaker and then as one system by estimating limited dependent variable models. We also evaluate the thresholds and estimate their optimal value subject to a policymaker with preferences assigning equal importance to both missed crisis and false crisis prediction errors. Moreover, impact of statistical data revisions on crisis predictions is examined. The results show, that the tested indicators perform better for the euro area in comparison to the non-euro area. The external sector indicators along with the new labour market indicators seem to have the best prediction abilities. Our outcomes also suggest that if the Macroeconomic Imbalance Procedure had been employed as an early warning system before the recession in 2009, it would have provided moderately useful alerts in terms of crisis prediction. However, this would mostly have applied to the EA countries and for only few indicators.

D3.3: Fiscal risk-sharing in response to shocks: New lessons for the euro area from the US (CEPS)

Abstract: Discussions on European integration have been influenced for a long time by the experience of the US, whose unemployment insurance (UI) system is often portrayed as an effective tool to respond to idiosyncratic shocks and one that missing in the euro area (EA). This paper investigates the extent to which this is the case in reality. It first offers empirical evidence that EA member states manage to provide a higher degree of insurance against asymmetric shocks (about 20%) than that provided by the US federal budget, which insures through inter-state fiscal risk-sharing (11%). It also shows that the larger budgets of EA member states do not explain this trend alone. Second, the paper finds that the US UI system is mostly relevant a as stabilisation mechanism in the face of US-wide shocks, rather than idiosyncratic shocks. We explain this by highlighting the institutional features of the US UI system as well as the existence of market mechanisms for inter-state risk-sharing. We draw two main lessons for the EA. First, the same system is unlikely to produce the same effects, given the structural features of the EA economies and the lack of effective market mechanisms. Second, a key role of the US federal UI system is to extend the duration and generosity of unemployment benefits in order support states, this tends to be associated with nation-wide recessions and it is the result of a discretionary Congress decisions rather than automatic mechanisms.

D3.4: Towards an EU budget with an effective stabilisation function (CEPS)

Abstract: This policy paper reviews to what extent EU budgetary tools provide a shock mitigation function and aims at exploring potential avenues to reform them to strengthen their stabilisation role. The EU budget is based on principles of medium-term budgeting, co-financing rules with fixed areas of intervention and a very limited possibility for budgetary reallocations. This rigid system makes EU financial support rather ill-suited to address a situation of fiscal emergency when a member state has to react to shocks. Nevertheless, there is evidence of a growing mandate for a stabilisation function within the EU budget, developed particularly in response to labour market shocks. The Youth Employment Initiative and the European Globalisation Adjustment Fund, despite their modest results, represent a concrete step toward introducing shock mitigation among the objectives of EU expenditure. Flexibility arrangements introduced over recent years within the EU budget also move in the direction of adapting the EU budgetary architecture to make it better suited to medium-term ex post shock mitigation. The revenue side of the EU budget is also found to contribute to stabilisation. We argue that the EU policy design to address stabilisation, as developed so far, is not performing and is not apt to the task. As resistances to enhancing the stabilisation capacity are lower at EU than EMU level, we explore room for reform for the post-2020 budget and propose and integrated approach to boost the responsiveness of the EU budget to unforeseen event throw the establishment of an EU fund for Employment and an extended mandate for the European Union Solidarity Fund.