Most recent papers:

• Financial fair play in European football.
  Thomas Peeters, Stefan Szymanski.
  Economic Policy. May 30, 2014
  In 2010 UEFA, the governing body of European football, announced a set of financial restraints, which clubs must observe when seeking to enter its competitions, notably the UEFA Champions League. We analyse the financial and sporting impact of these ‘Financial Fair Play’ (FFP) regulations in four major European football leagues. We first discuss the details of FFP and frame these regulations in the institutional set‐up of the European football industry. We then show how the break‐even constraint embedded in FFP could substantially reduce average payrolls and wage‐to‐turnover ratios, while strengthening the position of the traditional top teams. Since the benefits of the break‐even rule to consumers remain unclear, we argue that these rent‐shifting regulations might fall foul of European competition law. — Thomas Peeters and Stefan Szymanski

  May 30, 2014   doi: 10.1111/1468-0327.12031   open full text
• Mark‐to‐market accounting and systemic risk: evidence from the insurance industry.
  Andrew Ellul, Chotibhak Jotikasthira, Christian T. Lundblad, Yihui Wang.
  Economic Policy. May 30, 2014
  One of the most contentious issues raised during the recent crisis has been the potentially exacerbating role played by mark‐to‐market accounting. Many have proposed the use of historical cost accounting, promoting its ability to avoid the amplification of systemic risk. We caution against focusing on the accounting rule in isolation, and instead emphasize the interaction between accounting and the regulatory framework. First, historical cost accounting, through incentives that arise via interactions with complex capital adequacy regulation, does generate market distortions of its own. Second, while mark‐to‐market accounting may indeed generate fire sales during a crisis, forward‐looking institutions that rationally internalize the probability of fire sales are incentivized to adopt a more prudent investment strategy during normal times which leads to a safer portfolio entering the crisis. Using detailed, position‐ and transaction‐level data from the US insurance industry, we show that (a) market prices do serve as ‘early warning signals’, (b) insurers that employed historical cost accounting engaged in greater degrees of regulatory arbitrage before the crisis and limited loss recognition during the crisis, and (c) insurers facing mark‐to‐market accounting tend to be more prudent in their portfolio allocations. Our identification relies on the sharp difference in statutory accounting rules between life and P&C companies as well as the heterogeneity in implementation of these rules within each insurance type across US states. Our results indicate that regulatory simplicity may be preferred to the complexity of risk‐weighted capital ratios that gives rise, through interactions with accounting rules, to distorted risk‐taking incentives and potential build‐up of systemic risk. — Andrew Ellul, Chotibhak Jotikasthira, Christian T. Lundblad and Yihui Wang

  May 30, 2014   doi: 10.1111/1468-0327.12030   open full text
• Public policy and resource allocation: evidence from firms in OECD countries.
  Dan Andrews, Federico Cingano.
  Economic Policy. May 30, 2014
  The relationship between a firm's size and its productivity level varies considerably across OECD countries, suggesting that some countries are more successful at channelling resources to high productivity firms than others. In this paper, we examine the extent to which these differences depend on regulations affecting product, labour and credit markets, and assess their relevance for aggregate productivity. To this purpose, we exploit a decomposition of industry productivity into a moment of the firm productivity distribution (the unweighted mean), and a moment of the joint distribution with firm size (the covariance between productivity and market shares – allocative efficiency). We apply such decomposition to a cross section of more than 800 country‐industry cells and estimate the relevance of regulation policies for each of the two terms exploiting cross‐industry differences in exposure to the policy. Our results suggest that there is an economically and statistically robust negative relationship between policy‐induced frictions and productivity, though the specific channel depends on the policy considered. In the case of employment protection legislation, product market regulations (including barriers to entry and bankruptcy legislation) and restrictions on foreign direct investment, this is largely traceable to the worsening of allocative efficiency (i.e. a lower correspondence between a firm's size and its productivity level). By contrast, the adverse impact of financial market under‐development on aggregate productivity tends to arise through shifts in the firm productivity distribution (i.e. a lower unweighted mean). Furthermore, stringent regulations are more disruptive to resource allocation in more innovative sectors. — Dan Andrews and Federico Cingano

  May 30, 2014   doi: 10.1111/1468-0327.12028   open full text
• Systemic risk, sovereign yields and bank exposures in the euro crisis.
  Niccolò Battistini, Marco Pagano, Saverio Simonelli.
  Economic Policy. May 30, 2014
  Since 2008, eurozone sovereign yields have diverged sharply, and so have the corresponding credit default swap (CDS) premia. At the same time, banks' sovereign debt portfolios have featured an increasing home bias. In this paper, we investigate the relationship between these two facts, and its rationale. First, we inquire to what extent the dynamics of sovereign yield differentials relative to the swap rate and CDS premia reflect changes in perceived sovereign solvency risk or rather different responses to systemic risk due to the possible collapse of the euro. We do so by decomposing yield differentials and CDS spreads in a country‐specific and a common risk component via a dynamic factor model. We then investigate how the home bias of banks' sovereign portfolios responds to yield differentials and to their two components, by estimating a vector error‐correction model on 2007–13 monthly data. We find that in most countries of the eurozone, and especially in its periphery, banks' sovereign exposures respond positively to increases in yields. When bank exposures are related to the country and common risk components of yields, it turns out that (1) in the periphery, banks increase their domestic exposure in response to increases in country risk, while in core countries they do not; (2) in most eurozone countries banks respond to an increase in the common risk factor by raising their domestic exposures. Finding (1) suggests distorted incentives in periphery banks' response to changes in their own sovereign's risk. Finding (2) indicates that, when systemic risk increases, all banks tend to increase the home bias of their portfolios, making the eurozone sovereign market more segmented. — Niccolò Battistini, Marco Pagano and Saverio Simonelli

  May 30, 2014   doi: 10.1111/1468-0327.12029   open full text
• What drives TARGET2 balances? Evidence from a panel analysis.
  Raphael A. Auer.
  Economic Policy. March 10, 2014
  What are the drivers of the large TARGET2 (T2) balances that have emerged in the eurozone since the start of the financial crisis in 2007? This paper examines the extent to which changes in national T2 balances can be statistically associated with cross‐border private capital flows and current account (CA) balances. In a quarterly panel spanning the years 1999 to 2012 and 12 countries, it is shown that while the CA and changes in T2 balances were unrelated until the start of the 2007 financial crisis, since then the relation between these two variables has become statistically significant and economically sizeable. This reflects the ‘sudden stop’ in private sector capital that had hitherto funded CA imbalances. I next examine how different types of private capital flows have evolved over the last few years and how this can be related to changes in T2 balances, finding some deposit flight by private customers, a substantial retrenchment of cross‐border interbank lending, and also an increase in bank's holdings of high‐quality sovereign debt. My first conclusion from this analysis is that since T2 imbalances were caused by a sudden stop and are unlikely to grow without bounds as eurozone CA imbalances are currently diminishing at a rapid pace, there is no evidence that the institutional set‐up of the European monetary union needs to be reformed fundamentally. My further conclusions relate to how the current system transfers risks across the currency union. Limiting or settling T2 balances are not viable options. Rather, policies must be geared to limiting the implicit risk transfer from the private to the public sector within T2 creditor nations, which is facilitated by the current system as it may change the incidence of euro break‐up risk. — Raphael A. Auer

  March 10, 2014   doi: 10.1111/1468-0327.12024   open full text
• TARGET2 and central bank balance sheets.
  Karl Whelan.
  Economic Policy. March 10, 2014
  The eurozone's TARGET2 payments system has featured heavily in academic and popular discussions of the euro crisis. Some of this commentary has described the system as being responsible for a ‘secret bailout’ of Europe's periphery. Another common theme has been that the system has built up large credit risks for Germany should the euro break up. This paper discusses the TARGET2 system, focusing in particular on how it impacts the balance sheets of the central banks that participate in the system. It discusses the factors driving TARGET2 balances, considers some counterfactual cases in which eurozone monetary policy might have operated differently, examines the risks to Germany and considers proposals for settlement of these balances.
— Karl Whelan

  March 10, 2014   doi: 10.1111/1468-0327.12025   open full text
• Identifying channels of credit substitution when bank capital requirements are varied.
  Shekhar Aiyar, Charles W. Calomiris, Tomasz Wieladek.
  Economic Policy. March 10, 2014
  What kinds of credit substitution, if any, occur when changes to banks’ minimum capital requirements induce them to change their willingness to supply credit? The question is of first‐order importance given the emergence of ‘macro‐prudential’ policy regimes in the wake of the global financial crisis, under which regulatory tools – in particular, minimum capital ratio requirements for banks – will be employed to control the supply of bank credit as part of the effort to improve the resilience of the financial system. Regulatory efforts to influence the aggregate supply of credit may be thwarted to some degree by ‘leakages’, as other credit suppliers substitute for the variation induced in the supply of credit by regulated banks. Credit substitution could occur through foreign banks operating domestic branches that are not subject to capital regulation by the domestic supervisor, or through bond and stock markets. The UK experience for the period 1998–2007 is ideally suited to address these questions, given its unique regulatory history (UK bank regulators imposed bank‐specific and time‐varying capital requirements on regulated banks), the substantial presence of both domestically regulated and foreign regulated banks, and the UK's deep capital markets. In this study we show that foreign‐regulated branches are indeed an important source of credit substitution. Leakage by foreign regulated branches can occur either as a result of competition between branches and regulated banks that are parts of separate banking groups, or because a foreign banking group shifts loans from its UK‐regulated subsidiary to its affiliated branch, which is not subject to UK capital regulation. Our results suggest the presence of both channels is important, but the responsiveness of affiliated branches is substantially stronger (roughly twice as strong). We do not find any evidence for leakages through capital markets. That result may reflect the possibility that under non‐crisis conditions loan substitution through unregulated banks enjoys informational, monitoring and cost advantages over substitution via securities markets. This evidence has important policy implications: (1) because significant leakages result from interbank competition, in addition to loan transfers within affiliated entities of the same banking groups, forcing foreign banks to consolidate their operations in each country into either a foreign branch or a foreign subsidiary will not solve the leakage problem; and (2) international cooperation will be necessary to prevent regulatory arbitrage between domestically regulated banks and foreign branches. — Shekhar Aiyar, Charles W. Calomiris and Tomasz Wieladek

  March 10, 2014   doi: 10.1111/1468-0327.12026   open full text
• Defying gravity: can Japanese sovereign debt continue to increase without a crisis?
  Takeo Hoshi, Takatoshi Ito.
  Economic Policy. March 10, 2014
  Japan has the highest debt to GDP ratio among advanced countries, and many studies find that the current fiscal regime of Japan is not sustainable. Yet, the Japanese government bond continues to enjoy low and stable interest rates. The most plausible explanation for such an apparent anomaly is that the bonds are predominantly held by the Japanese residents, who are willing to absorb increasing amount of Japanese Government Bonds (JGB) without requiring high yields. Even if the Japanese residents continue to invest their new saving into the government bonds, however, Japan's fiscal situation is not sustainable, which this paper shows through simulations under various scenarios. In all of the scenarios that assume the fiscal policy stance of the Japanese government does not change in the future, we find that the amount of government debt will exceed the private sector financial assets available for the government debt purchase in the next 10 years or so. The paper also shows that sufficiently large tax increases and/or expenditure cuts in the future would put the government debt on a sustainable path. Thus, if the market believes that Japan will embark on such fiscal consolidation in the next 10 years, at most, the low JGB yields are justifiable. If and when the expectation changes, however, a fiscal crisis can be triggered even before the government debt hits the ceiling of the private sector financial assets. — Takeo Hoshi and Takatoshi Ito

  March 10, 2014   doi: 10.1111/1468-0327.12023   open full text
• The Greek debt restructuring: an autopsy.
  Jeromin Zettelmeyer, Christoph Trebesch, Mitu Gulati.
  Economic Policy. July 15, 2013
  The Greek debt restructuring of 2012 stands out in the history of sovereign defaults. It achieved very large debt relief – over 50% of 2012 GDP – with minimal financial disruption, using a combination of new legal techniques, exceptionally large cash incentives, and official sector pressure on key creditors. But it did so at a cost. The timing and design of the restructuring left money on the table from the perspective of Greece, created a large risk for European taxpayers, and set precedents – particularly in its very generous treatment of holdout creditors – that are likely to make future debt restructurings in Europe more difficult. — Jeromin Zettelmeyer, Christoph Trebesch and Mitu Gulati

  July 15, 2013   doi: 10.1111/1468-0327.12014   open full text
• Heterogeneous transmission mechanism: monetary policy and financial fragility in the eurozone.
  Matteo Ciccarelli, Angela Maddaloni, José‐Luis Peydró.
  Economic Policy. July 15, 2013
  The eurozone economic activity and banking sector have shown substantial fragility over the last years with remarkable country heterogeneity. Using detailed data on lending conditions and standards, we analyse – along several key dimensions of heterogeneity – how financial fragility has affected the transmission mechanism of the single eurozone monetary policy. The analysis shows that the monetary transmission mechanism is time‐varying and influenced by the financial fragility of the sovereigns, banks, firms and households. The impact of monetary policy on aggregate output is stronger during the financial crisis, especially in countries facing increased sovereign financial distress. This amplification mechanism, moreover, operates through the credit channel, both the bank lending and the non‐financial borrower balance‐sheet channels. Our results suggest that the bank‐lending channel has been to a large extent neutralized by the ECB non‐standard monetary policy interventions, but the policy framework until the end of 2011 was insufficient to overcome credit availability problems stemming from deteriorated firm net worth and risk conditions, especially for small firms in countries under stress. — Matteo Ciccarelli, Angela Maddaloni and José‐Luis Peydró

  July 15, 2013   doi: 10.1111/1468-0327.12015   open full text
• Bank lending and monetary transmission in the euro area.
  Roberto A. Santis, Paolo Surico.
  Economic Policy. July 15, 2013
  To what extent does the availability of credit depend on monetary policy? And, does this relationship vary with bank characteristics? Based on a common source of balance sheet data for the four largest economies of the eurozone over the period 1999–2011, we find that the effects of monetary policy on bank lending are significant and heterogeneous in Germany and Italy – which are characterized by a large number of banks – but are weaker and more homogeneous in Spain and France – whose banking industry has a higher degree of market concentration. In particular, monetary policy appears to exert larger effects on cooperative and savings banks with lower liquidity and lesser capital in Germany and savings banks with smaller size in Italy. Our results highlight that the transmission of monetary policy over bank lending in the eurozone is highly heterogeneous. From a policy perspective, the increased large number of cooperative and savings banks, which have had access during the last financial crisis to the refinancing operations of the European Central Bank, bodes well for the improvement of the monetary transmission mechanism. The analysis also suggests that competition policy measures aiming at reducing entry barrier might facilitate the transmission mechanism. — Roberto A. De Santis and Paolo Surico

  July 15, 2013   doi: 10.1111/1468-0327.12013   open full text
• Fiscal union in Europe? Redistributive and stabilizing effects of a European tax‐benefit system and fiscal equalization mechanism.
  Olivier Bargain, Mathias Dolls, Clemens Fuest, Dirk Neumann, Andreas Peichl, Nico Pestel, Sebastian Siegloch.
  Economic Policy. July 15, 2013
  The current debt crisis has given rise to a debate concerning deeper fiscal integration in Europe. The view is widespread that moving towards a ‘fiscal union’ would have stabilizing effects in case of macroeconomic shocks. We study the economic effects of introducing two elements of a fiscal union: an EU‐wide tax and transfer system and a fiscal equalization mechanism. Using the European tax‐benefit calculator EUROMOD, we exploit representative household micro data from 11 eurozone countries to simulate these policy reforms and study their effects on the income distribution and automatic stabilizers. We find that replacing one third of the national tax‐benefit systems with a European system would lead to significant redistributive effects both within and across countries. These effects depend on income levels and the structures of existing national systems. The EU system would particularly improve fiscal stabilization in credit constrained countries absorbing 10–15% of a macroeconomic income shock. Introducing a fiscal equalization mechanism would redistribute revenues from high to low income countries. However, the stabilization properties of this system are ambiguous. The results suggest that it might be necessary for Europe to explore alternative ways of improving macroeconomic stability without redistributing income ex ante. — Olivier Bargain, Mathias Dolls, Clemens Fuest, Dirk Neumann, Andreas Peichl, Nico Pestel and Sebastian Siegloch

  July 15, 2013   doi: 10.1111/1468-0327.12011   open full text