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FIW Working Papers

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Real Exchange Rates, Current Accounts and Competitiveness Issues in the Euro Area

FIW Working Paper N° 173


Rajmund Mirdala- December 2016



The lack of nominal exchange rate flexibility in the monetary union induced the growing divergence of trade performance among the member countries. Intra-Eurozone current account imbalances among countries with different income levels per capita fuel discussions on competitiveness channels under common currency. Asynchronous current account trends between North and South of the Euro Area were accompanied by significant appreciations of real exchange rate in the periphery economies originating in the strong shifts in consumer prices and unit labor costs in these countries relative to the countries of the Euro Area core. The issue is whether the real exchange rate is a significant driver of persisting current account imbalances in the Euro Area considering than, according to some authors, differences in domestic demand are more important than is often realized. In the paper we analyze main aspects of current account adjustments in the Euro Area member countries. From estimated VAR model we calculate impulse-response function of the current account to the real exchange rate (REER calculated on CPI and ULC base) and domestic demand shocks and variance decomposition to examine the relative importance of both shocks. Our results indicate that while the prices and costs related determinants of external competitiveness affected imports more significantly than exports, demand drivers shaped current account balances mainly during the crisis period.


JEL:                 C32, F32, F41

Keywords:       current account, real exchange rate, economic crisis, vector autoregression, impulse-response function, variance decomposition

Foreign Branches of US Global Banks: Geography, Balance Sheet Structure and Contagion

FIW Working Paper N° 172


Carmela D’AVINO- April 2016


Abstract: This paper contributes to the understanding of the international financial linkages created by US banks by looking at the geographical composition and structure of the balance sheet of foreign branches. The empirical investigation, which is based on a novel dataset containing balance sheet statistics of foreign branches by country of location, has a threefold objective. First, it provides geographical mapping and distribution of foreign activities of branches by host country by accounting also for those balance sheet items not included in the available international banking statistics, i.e. gross interoffice positions and transactions with third-countries. Secondly, this paper presents a classification of host countries by balance sheet structure of foreign offices. A partioning-based clustering analysis allows to identify 4 distinct types of foreign branches: liquidity importers, liquidity exporters, liquidity conduits and locally implanted. Lastly, the paper provides evidence in support of the fact that US branches’ banking foreign operations are a good measure of financial integration with US as they can significantly explain business cycle synchronisation between the host country and the US during the Great Recession.


JEL:                 F33, F34, F36, F42, C23, C49

Keywords:     US global banks; Foreign branches; Balance sheet structure; Contagion

Exchange Rate Pass-Through in the Euro Area

FIW Working Paper N° 171

Rajmund Mirdala- April 2016


Abstract: Time-varying exchange rate pass-through effects to domestic prices under fixed euro exchange rate perspective represent one of the most challenging implications of the common currency. The problem is even more crucial when examining crisis related redistributive effects associated with relative price changes. The degree of the exchange rate pass-through to domestic prices reveals its role as the external price shocks absorber especially in the situation when the leading path of exchange rates is less vulnerable to the changes in the foreign prices. Adjustments in domestic prices followed by exchange rate shifts induced by sudden external price shocks are associated with changes in the relative competitiveness among member countries of the currency area. In the paper we examine exchange rate pass-through to domestic prices in the Euro Area member countries to examine crucial implications of the nominal exchange rate rigidity. Our results indicate that absorption capabilities of nominal effective exchange rates clearly differ in individual countries. As a result, an increased exposure of domestic prices to the external price shocks in some countries represents a substantial trade-off of the nominal exchange rate stability.


JEL:                 C32, E31, F41

Keywords:     exchange rate pass-through, inflation, Euro Area, VAR, impulse-response function

Jobs in global supply chains: a macroeconomic assessment

FIW Working Paper N° 170

Takaaki Kizu, Stefan Kühn und Christian Viegelahn- März 2016


Abstract: In its recent World Employment and Social Outlook, the ILO published estimates of the number of jobs related to global supply chains (GSCs) for 40 countries in 1995-2013. This paper provides a detailed description of the methodology that was used for the estimation and documents in more detail global linkages in production, becoming apparent on the labour market. The paper also shows new evidence on the number of jobs supported by different export destinations and analyzes the number of GSC-related jobs in different country groups. In particular, we find evidence for the changing role of China, from a country in which GSC-related jobs are located to a country whose import demand creates these jobs elsewhere. We also show that production linkages between emerging economies create an increasing number of jobs. When focusing on jobs related to manufacturing GSCs, trends in GSC-related jobs reveal the increasing importance of the services sector. Finally, we conduct a sectoral regression analysis and provide evidence that increased GSC participation of a sector as a supplier can be associated with a drop in the wage share.


JEL:                 F16, F66

Cross-Border M&As and Eco-Environmental Performance of European Energy Utilities

FIW Working Paper N° 169

Evgenii Monastyrenko - März 2016


Abstract: European electricity industry has recently come through liberalization. Surge of intakes with high share of cross-border deals was market players’ response. Measuring of post-merger performance alterations is a central question of M&A literature. EU energy sector is responsible for significant part of global greenhouse gas emissions. Its efficiency should be regarded with respect to ecological dimension. This study addresses combined economic and environmental performance of 15 biggest European energy producers in 2005-2013. I exploit Data envelopment analysis (DEA) with CO2 as an undesirable output. Panel fractional regression model with financial controls is used to isolate effects of completed mergers. Results suggest that in short term firms profit from selling their subsidiaries to foreign counter-parties. This effect doesn’t sustain over time. Same-type domestic deals are detrimental in short run, but performance-enhancing in long term. Domestic and cross-border acquisitions immediately damage performance. Later ones stimulate efficiency in the long run.


JEL:                 F21, G34, L25, L94, D24

Keywords:     Mergers and acquisitions, Firm performance, Data envelopment analysis, Fractional regression model, Electric power industry, Carbon dioxide emissions

Drivers of global liquidity and global bank flows: A view from the euro area

FIW Working Paper N° 168

Mary Everett - März 2016


Abstract: This paper exploits a novel bank-level monthly dataset to assess the effects of global liquidity on the global flows of euro area banks. The period associated with the European sovereign debt crisis has witnessed increased growth in euro area bank claims on extra-euro area residents, against a background of contracting euro area credit supply. Controlling for bank risk, global credit demand, and price effects such as interest rate differentials and exchange rates, empirical evidence supports a range of determinants of global liquidity - including global risk, global bank equity and unconventional monetary policy in the US, UK, Japan and euro area - as drivers of the global flows of euro area banks. Moreover, regression analysis indicates heterogeneity in the influence of global liquidity on global flows across euro area bank type, defined by their balance sheet composition and country of residence (stressed versus non-stressed euro area countries). The results highlight the importance of exogenous factors as drivers of global bank flows and the potential for international leakages of unconventional monetary policy.


JEL:                 F60, G15, G21

Keywords:     Global bank flows, cross-border banking, global risk, global liquidity, European sovereign crisis, unconventional monetary policy spillovers, credit supply

Evaluation of unconventional monetary policy in a small open economy

FIW Working Paper N° 167

Martin Pietrzak - März 2016


Abstract: This paper shows what are the consequences of omitting international dimension issues like international trade and financial channels when modeling the effects of unconventional monetary policy tools. To evaluate the size of discrepancies between consequences of a large-scale asset purchase program in a small open economy and a closed one, we extend one of the existing models analyzing a large-scale asset purchases by adding small open economy features. Finally we compare it with the original version.

We find that previous studies might overestimate the extent to what large-scale asset purchases affect real activity. Allowing agents to trade internationally with goods as well as saving via foreign, currency denominated deposits leads to a leakages that result in substantial differences between large-scale asset purchases in a small open economy and an autarky. Moreover, our results show that negative supply side shocks have less severe consequences in a small open economy comparing to an autarky, because they are offset by the real exchange rate depreciation which boosts competitiveness


JEL:                 E52, F41

Keywords:     unconventional monetary policy, financial frictions, small open economy

Asymmetric Credit Growth and Current Account Imbalances in the Euro Area

FIW Working Paper N° 166

Robert Unger - Februar 2016


Abstract: The euro area crisis is often linked to the emergence of current account imbalances. As most of the deficit countries experienced pronounced credit booms at the same time that these imbalances were building up, this paper investigates the link between domestic credit developments and the current account balance. Using a panel error correction specification, the estimation results show that flows of bank loans to the non-financial private sector are a significant determinant of the current account and that they – together with changes in competitiveness – constituted the most important factor driving the build-up of current account imbalances in the deficit countries. Accordingly, impeding an increase in private sector indebtedness seems to be a promising way to dampen the formation of unsustainable current account imbalances.


JEL:                E50, F32, F45, G21

Keywords:      banks, credit growth, current account imbalances, euro area

Productivity effects from inter-industry offshoring and inshoring: Firm-level evidence from Belgium

FIW Working Paper N° 165

Bruno Merlevede and Angelos Theodorakopoulos - Februar 2016


Abstract: In this paper we confirm the existence of improvements of firm productivity when domestic upstream and downstream firms become more internationalized and therefore offshore (import intermediate inputs) and inshore (export final output for intermediate input usage) intensively. China’s accession to the WTO, which in the case of Belgium reduced trade barriers to China, help us confirm that these inter-industry productivity improvements can also be generated form a quasi-trade liberalization event. Upstream linkages are the dominant source of these productivity benefits and are reaped mainly from medium-low tech, labor intensive and upstream industries. Finally, we draw upon the importance of biases in our results from misspecifications common in the literature. From ignoring the dynamic nature of productivity, results appear overestimated or with sign reversals. From estimating a value-added instead of a gross-output production function, results become spurious.


JEL:                 F2, F14, F15

Keywords:     Offshoring, supply chain, spillovers, productivity

Impact of Services Trade on India’s Economic Growth and Current Account Balance: Evidence from Post-Reform Period

FIW Working Paper N° 164

Mini P. Thomas - Februar 2016


Abstract: Economic Growth and External Stabilisation (defined in terms of Current Account Balance as a percentage of GDP) is a top priority for policy-makers, while laying out the macroeconomic framework for Indian economy. Government of India had targeted for an average GDP growth rate of 9 percent and a Current Account Deficit (CAD) below 2.5 percent of GDP during the five-year period from 2012-2017. However, the actual CAD of Indian economy widened to 4.2% of GDP in 2011-12, and further reached a historic high CAD of 4.7 percent of GDP in 2012-13. Given such a scenario, this paper aims to estimate the impact of services trade on India’s Economic Growth and Current Account Balance, during the post-reform period from 1990-91 to 2011-12. Facilitated by economic globalisation, domestic liberalization, and technological advances which resulted in increasing international fragmentation of the production process, India’s services trade began growing rapidly post 1991. With the help of Thirlwall’s Balance of Payments Constrained Growth Model and ARDL approach to cointegration, this study estimates and establishes the crucial role of services trade in achieving the policy objectives of economic growth and external stabilisation simultaneously for Indian economy. This study also examines the impact of services exports on India’s economic growth, by comparing the latest officially published input-output table of India for 2007-08, with that of 1993-94. Among the major services in India’s export basket, construction, transport and business services are found to exhibit strongest backward linkages, and hence can act as engines of export-led growth. Role of services imports in India’s export-led growth and the import content going into production of India’s services exports is analysed using the TIVA database for 1995 and 2008, which have implications for India’s external stabilisation. Foreign value added content in India’s services exports is found to be highest in case of business services, transport services and telecommunications.


JEL:                        F14, F32, F43, C67

Keywords:            Services Trade, Current Account Deficit, Economic Growth, Backward Linkages, Trade in Value Added

What if all countries were actually in the same boat? A comparison of countries’ vulnerability based on Markov Switching Models

FIW Working Paper N° 163

Brendan Vannier - Februar 2016


Abstract: This article aims at assessing the main characteristics of the business cycle of 80 developed and developing countries. By comparing the possibility for these economies to enter or to exit a recession and the associated consequences, it aims at complementing existing literature with regard to scale and/or frequency of the study. Following the usual definition of a recession, an algorithmic classification tends to show that, surprisingly, developed and developing countries face similar probabilities to enter or to exit a recession, respectively around 5% and 18%. This aspect contradicts existing literature, which often advocates a greater volatility of developing countries’ business cycle with more frequent recessions. However emerging markets and economies face output per capita losses around twice as important as advanced ones when they undergo a recession. These observations are then tested using a non-linear parametric Markov-Switching Model. If the statistical validity of this method is bound by data availability, it echoes in a really good manner the pattern derived using a non-parametric approach. Estimating the model on the cyclical component of the series, derived using an HP filter, fits the best previous remarks. It also replicates other major characteristics. Indeed while developed countries form a rather homogeneous group, developing countries demonstrate greater heterogeneity. Latin American countries appear as the most vulnerable ones whereas Asian countries perform better than all other groups.


JEL:                 F43; C32; O57

Keywords:       Business Cycles, Economic Growth, Vulnerability, Markov Switching Models.

Capital Market Imperfections and Trade Liberalization in General Equilibrium

FIW Working Paper N° 162


Michael Irlacher and Florian Unger - Februar 2016


Abstract: This paper develops a new international trade model with capital market imperfections and endogenous borrowing costs in general equilibrium. A key element of our model is that firm heterogeneity arises from the interaction of credit constraints at the firm-level with financial frictions at the country-level. Producers differ in pledgeability of sales which results in firm heterogeneity, if financial institutions are imperfect. We show that endogenous adjustments of capital costs represent a new channel that reduces common gains from globalization. Trade liberalization increases the borrowing rate, leads to a reallocation of market shares towards unconstrained producers and a larger fraction of credit-rationed firms. This increases the within-industry variance of, sales and reduces welfare gains as consumers dislike price heterogeneity. Our theory is consistent with new empirical patterns from World Bank firm-level data. We highlight that credit frictions are positively related to the degree of product market competition and to the variance of sales across firms.


JEL:                 F10, F36, F61, L11

Keywords:       Credit constraints, General equilibrium, Globalization, Imperfect capital markets, Welfare