FIRSTRUN Deliverable 4.6 published: A description of the macroprudential policy block of the NiGEM model

Abstract: In this paper we incorporate a macroprudential policy model within a semi-structural global macroeconomic model, NiGEM. The existing NiGEM model is expanded to include two macroprudential tools: loan-to-value ratios on mortgage lending and variable bank capital adequacy targets. The former has an effect on the economy via its impact on the housing market while the latter acts on the lending spreads of corporate and households. A systemic risk index that tracks the likelihood of the occurrence of a banking crisis is modelled to establish thresholds at which macroprudential policies should be activated by the authorities. Explicit modelling of a systemic risk index also allows for a cost-benefit analysis of macroprudential policy.

Authors:
Oriol Carreras, NIESR
Philip Davis, NIESR and Brunel University
Iana Liadze, NIESR
Rebecca Piggott, NIESR
James Warren, NIESR

One of the most striking economic governance trends of recent years has been the increased resort to fiscal rules. In the EU as a whole, the number of fiscal rules recorded by the European Commission in its fiscal rules database has risen nearly tenfold since the early 1990s. Such rules have varied considerably across countries. Nearly all EU Member States have also now established Fiscal Councils as independent agencies to monitor the conduct of fiscal policy.

Starting with the Stability and Growth Pact, the EU has been a prime mover in stimulating rule-based governance. Many of the reforms enacted in response to the years of crisis since 2008 were intended to tie the hands of governments even more by establishing norms not only for fiscal discipline, but also for curbing other macroeconomic imbalances. The changes also provide for more intensive monitoring of national policy-making by the EU level and undeniably constitute a far-reaching package.

The national case studies provide a detailed examination of fiscal and other rules in four EU Member States: Italy, Poland, Slovakia and the UK. Two of these are members of the Euro Area, Poland is a non-Euro signatory of the Fiscal Compact, but the UK, even before the Brexit referendum result, was bound much more loosely by EU rules.

The case studies have examined the application of the rules, drawing on a range of documents and on interviews with public officials responsible for the implementation of the rules and with experts knowledgeable about the respective countries. They sought to explore how the processes and mechanisms of fiscal governance function, the interplay between national and EU rules and what they imply for the coherence of the policy system and, more generally, to investigate the political economy of rules.

Deliverable 6.5: Fiscal rules and other rule-based mechanisms in practice: introduction to case studies of four Member States (LSE, LUISS, CASE, IER SAS)

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.

A new deliverable on government debt deleveraging by Alexandre Lucas Cole (LUISS Guido Carli), Chiara Guerello (LUISS Guido Carli), and Guido Traficante (European University of Rome) has been published today:

D4.4: Government Debt Deleveraging in the EMU

Abstract: We evaluate the stabilization properties and welfare implications of different government debt deleveraging schemes and instruments for deleveraging in a currency union. In a two-country new-Keynesian DSGE model, with a debt-elastic government bond spread and incomplete international financial markets, we study the effects of government debt deleveraging, under a range of alternative shocks and under alternative scenarios for fiscal policy coordination. We find that greater stabilization is achieved by backloading the deleveraging process and when the two countries reduce the net exports gap. Moreover, taxes are a better instrument for deleveraging compared to government consumption or transfers. Our policy prescriptions for the Eurozone are to reduce government debt more gradually over time and less during recessions and to do so using distortionary taxes, while concentrating on reducing international demand imbalances.

Deliverable 6.4 by Iain Begg (LSE) has been published today:

Fiscal and other rules in EU economic governance: helpful, largely irrelevant or unenforceable?

Abstract: EU Member States have been pushed to adopt more extensive and intrusive fiscal rules, particularly in the euro area, but also in other EU Member States, yet evidence that they are succeeding is, at best, tentative. The EU level Stability and Growth Pact (SGP) has been – and remains – the most visible such rule, but has been complemented by a profusion of national rules and by new provisions on other sources of macroeconomic imbalance. Much of the analysis of rules has concentrated on their technical merits, but tends to neglect the political economy of compliance. This paper examines the latter looking at compliance with fiscal rules at EU and Member State levels, and at the rule-based mechanisms for curbing other macroeconomic imbalances. It concludes that politically-driven implementation and enforcement shortcomings are given too little attention, putting at risk the integrity and effectiveness of rules.

A new deliverable on Revisions of the cyclically adjusted budget balance published (D2.4, CEPS).

Abstract: The aim of this study is to analyse the revisions of the cyclically adjusted balances of the EU15 countries in order to learn whether the turn of the cycle is particularly prone to error and to evaluate whether the EU’s fiscal framework is well equipped for dealing with potential revisions. The analysis is conducted with real-time fiscal data published by the European Commission for the years 2003-2016. Our study finds that the cyclically adjusted balance forecasts as well as in-year estimates are heavily revised in the following years. Moreover first ex-post data are still significantly revised in the following years. We find no strong evidence to support the notion that these revisions are larger at the turn of the cycle and thus conclude that revisions are of a systematic nature. The revisions are large enough to cause significant differences in the ex-ante and ex-post assessments by the European Commission on whether member states achieved their structural targets. This study elaborates on the built-in flexibility in the Stability and Growth Pact (SGP), on which the Commission can capitalise to avoid unwarranted ex-post sanctioning. Moreover, the SGP entails several safeguards against revisions negatively affecting the policy advice given to member states, particularly with regard to sanctioning.

A new deliverable on measuring fiscal spillovers has been published:

D1.3: Measuring fiscal spillovers in EMU and beyond: A Global VAR approach (CEPS).

Abstract: This paper identifies and measures fiscal spillovers in the EU countries empirically, using a structurally stable global vector autoregression (GVAR) model. For our purposes, the individual EU countries, as well as the most important international trading partners, are modelled with a special focus on the effects of either single-country or coordinated fiscal shocks such as increases in fiscal spending. Our aim is to look at the sign and the absolute values of fiscal spillovers in a country-wise perspective and at the time profile (impulse response) of the impacts of fiscal shocks. For this purpose, we differentiate between the spillovers of fiscal shocks in specific EMU member countries and the spillovers of “regional” shocks, i.e. area-wide shocks to fiscal policy. Fiscal policy is measured by government expenditure, government revenues or the government budget balance, all as percentages of GDP. Special attention is paid to the question of whether or not spillovers are stronger within the EMU group than within the “Rest of Europe” due to tighter financial or trade links.

New deliverable by NIESR published: Macroprudential tools, transmission and modelling (D4.7).

Abstract: The purpose of this paper is twofold. First, we review the theoretical and empirical literature on macroprudential policies and tools. Second, we test empirically the effectiveness of several macroprudential policies and tools using three datasets from the IMF and BIS that cover up to 19 OECD countries during 2000-2014, thus giving wide coverage of instruments. In addition, our focus on OECD countries gives us access to a wider range of control variables whose omission may lead to excessively favourable results on the impact of macroprudential policies. We find evidence that macroprudential polices are effective at curbing house price and credit growth, albeit some tools are more effective than others. These include, in particular, taxes on financial institutions and strict loan-to-value and debt-to-income ratio limits.

A new deliverable by LUISS has been published: One EMU Fiscal Policy for the EURO (D3.2).

Abstract: We build a Two-Country Open-Economy New-Keynesian DSGE model of a Currency Union to study the effects of fiscal policy coordination, by evaluating the stabilization properties of different fiscal policy scenarios. Our main findings are the following: a) a government spending rule that targets net exports rather than domestic output produces more stable dynamics, b) consolidating government budget constraints across countries and moving tax rates jointly provides greater stabilization than with separate budget constraints and independent tax rate movements, c) taxes on labour income are exponentially more distortionary than taxes on firm sales. These findings point out to possible policy prescriptions for the Eurozone: to coordinate fiscal policies by reducing international demand imbalances, either by stabilizing trade flows across countries or by creating some form of fiscal union or both, while avoiding the excessive use of labour taxes, in favour of sales taxes.

New deliverable by IHS published: Cross-Country Long-Run Spillover Effects and Coordination of Fiscal Policy: a Quantitative Exploration for Europe (D1.6).

Abstract: We develop a multi-country CGE-OLG model with detailed structures for the households and the governments. We then perform simulations to quantify spillovers from policy reforms and exogenous shocks typical of crisis and compare some forms of policy coordination, without being comprehensive. In the standard labor and consumption tax reforms that we consider, we find that spillovers are small and that simultaneous implementation of these fiscal reforms, one example of coordination, is not advantageous. Spillovers from exogenous shocks are significantly larger and area-wide shocks have a larger impact than a shock to a country alone. The type of fiscal policy response to a shock matters. An appropriate coordinated policy response can improve domestic economic circumstances and reduce negative spillovers to other countries. The gains are larger in case of an area-wide exogenous shock, but only to a small extent. The temporary violation of public debt rules can be beneficial for all countries.